What Is a 409A Valuation? A Founder's Guide
A 409A valuation sets the strike price for your team's stock options. Get it wrong, and you'll face IRS penalties and destroy employee trust. Here’s how to do it right.
TL;DR: A 409A valuation is an independent appraisal of your startup’s common stock, required by the IRS to legally issue stock options. Your 409A value is much lower than your fundraising valuation, which is good for employees. Get one before your first option grant and refresh it annually or after a material event like a new financing round.
Key takeaways
- Get a 409A valuation before you issue your first stock option grant.
- Your 409A (common stock) will be 70-90% lower than your post-money (preferred stock) valuation.
- Choose a reputable provider recommended by your law firm; this is not the place to cut corners.
- Refresh your 409A every 12 months or immediately after raising a priced round of financing.
- Provide realistic 'management case' projections, not your aggressive 'investor pitch' forecast.
- Never verbally promise a specific strike price before the 409A valuation is complete.
A 409A valuation is one of those administrative hurdles that feels like a distraction until it becomes a five-alarm fire. You need it to legally grant stock options to your team. Get it wrong, and you cause a tax nightmare for your employees and risk invalidating your entire equity plan.
Think of it as the official price-setting mechanism for your employee stock options. The term comes from Section 409A of the IRS code, created post-Enron to stop executives from gaming their option prices. It requires an independent, qualified appraiser to determine the Fair Market Value (FMV) of your company’s common stock.
This appraisal gives you “safe harbor” with the IRS. With a compliant 409A in hand, the burden of proof is on the IRS to argue your strike price is wrong. Without it, the burden is on you to prove it’s right. That's a position you don’t want to be in.
Your 409A vs. Your Fundraising Valuation: Not the Same Thing
This is the single most common point of confusion for founders. The valuation you get from investors has almost nothing to do with your 409A valuation.
- Fundraising Valuation (Post-Money): This is the price VCs pay for preferred stock. Preferred shares are a different asset class with special rights: liquidation preferences (they get paid first), anti-dilution rights, and more.
- 409A Valuation (FMV): This assesses the value of common stock, the type you grant to employees. Common stock is last in line to get paid and lacks the contractual protections of preferred stock.
Because common stock has fewer rights and is highly illiquid, its value is significantly lower than preferred stock. A steep discount is not only normal—it's expected and beneficial for your team.
Example: You just raised a M seed round at a 0M post-money valuation. Your investors paid a price for
preferred shares that implies a
0M company value. Your 409A valuation, however, will value the
common stock. A typical discount might be 70–85%, resulting in a 409A valuation of
