What happens if we grant options below fair market value?

Employees face immediate ordinary income tax on the discount, plus additional 20% penalty tax under Section 409A, plus state penalties. Extremely expensive mistake — always issue options at or above the current 409A.

Can we time a 409A to lower our strike price?

Yes and no. You can time 409As between funding events (lower common price = lower strike). You cannot delay a 409A after a material event to keep the old (lower) price. Coordinate with counsel.

Does a new priced round always increase the 409A?

Almost always yes — preferred stock issued at higher price raises implied common value. Growth-stage rounds can raise 409A by 2-4x, dramatically increasing option strike prices for new hires.

409A Valuation: Methodology, Cadence, and Impact on Option

A 409A valuation sets the fair market value of your common stock, which becomes the strike price for employee options.

409A Valuations: What They Actually Do, and Why You Should Care About the Number

409A valuations sound like a boring compliance chore — you hire a valuation firm, they produce a report, you use the number as the strike price for new option grants, refresh every 12 months. The compliance layer is real: getting 409A wrong exposes employees to punitive tax treatment under Section 409A of the Internal Revenue Code. But the number itself is a business decision with real consequences. A high 409A hurts hiring competitiveness by giving new employees higher strike prices. A too-low 409A that can't be defended creates IRS exposure. Understanding the levers helps you get a defensible number that also serves the business.

When you need a 409A

Before issuing your first stock options. After any material corporate event: priced financing round, major acquisition offer, secondary transaction. Every 12 months at minimum, even absent material events. Valuations older than 12 months lose "safe harbor" protection under IRS rules.

Cost and providers

Cost: $2-5K at seed stage, $3-8K at Series A/B, $5-15K at Series C+ depending on complexity. Providers: Carta, Pulley, AngelList, Aranca, Scalar, Preferred Return. Cap table software providers typically bundle 409A into their annual pricing at a discount.

How valuations are calculated

Options Pricing Method (OPM): most common, values common stock based on option-like allocation between preferred and common. Backsolve: uses recent preferred round to derive common value. PWERM (Probability-Weighted Expected Return): used at later stages with multiple exit scenarios. All three are IRS-accepted.

Common preferred-to-common discount

Common stock typically trades at 20-40% discount to preferred at seed, narrowing to 10-25% at Series C+. The discount reflects preferred's liquidation preference, protective provisions, and dividend rights. Don't argue for lower discounts — the IRS reviews.

Frequently asked questions

What happens if we grant options below fair market value?: Employees face immediate ordinary income tax on the discount, plus additional 20% penalty tax under Section 409A, plus state penalties. Extremely expensive mistake — always issue options at or above the current 409A.
Can we time a 409A to lower our strike price?: Yes and no. You can time 409As between funding events (lower common price = lower strike). You cannot delay a 409A after a material event to keep the old (lower) price. Coordinate with counsel.
Does a new priced round always increase the 409A?: Almost always yes — preferred stock issued at higher price raises implied common value. Growth-stage rounds can raise 409A by 2-4x, dramatically increasing option strike prices for new hires.

Related fundraising guides (40)

Investor directory · Fundraising library · Articles A–Z · Company funding database