How to Get a 409A Valuation
A 409A valuation is required to price employee stock options. This guide explains why hiring a firm is non-negotiable and how to manage the process correctly.
TL;DR: A 409A valuation sets the strike price for employee stock options by determining the Fair Market Value (FMV) of your common stock. You must hire an independent firm to perform the valuation to get "safe harbor" from IRS penalties. The process takes 2-4 weeks, costs ,000-$6,000, and must be updated annually or after a material event like a new financing round.
Key takeaways
- You must get a 409A valuation before issuing your first stock options.
- Hire an independent valuation firm. DIY methods do not provide IRS safe harbor.
- A 409A expires after 12 months or after a material event, like a new financing.
- Expect to pay ,000-$6,000 and for the process to take 2-4 weeks.
- Your common stock (for options) is worth less than your preferred stock (for investors).
- Review the draft report for factual errors before your board approves it.
You Can't Afford to Get This Wrong: The Stakes and the "Safe Harbor"
As soon as you decide to grant stock options—to employees, advisors, or even contractors—you need a 409A valuation. It’s a formal appraisal that establishes the Fair Market Value (FMV) of your company’s common stock. This FMV becomes the minimum strike price for any option you grant.
Under IRS Section 409A, setting a strike price below the FMV creates "deferred compensation." This has disastrous tax consequences, not for your company, but directly for your employees. If you get it wrong, your team members could face:
- Immediate income tax on all their vested options.
- An additional 20% federal penalty tax on top of that.
- Interest penalties on the unpaid taxes.
- Potential state-level penalties, which can be just as severe.
This is a catastrophic, company-killing outcome for an early hire. To avoid it, you need to prove your valuation method was fair, reasonable, and defensible. This is where “safe harbor” comes in.
By hiring a qualified, independent third-party firm to conduct your 409A, you gain safe harbor status. This shifts the burden of proof to the IRS in an audit; they must prove your valuation was "grossly unreasonable." Without an independent valuation, the burden of proof is on you. That’s a fight you cannot win.
409A vs. Your Fundraising Valuation: Two Different Numbers
When you raise a priced round, investors buy preferred stock. The price they pay determines your "post-money valuation." A common founder mistake is assuming this price is the FMV for employee options.
It’s not. Preferred stock has superior economic rights and powers, most notably a liquidation preference. This guarantees investors get their money back first in an exit. Because of these rights, preferred stock is more valuable than the common stock you grant to employees.
A 409A valuation calculates the specific, lower value of this common stock. For example, if you raise a seed round at a
