Equity & Ownership

409A Valuations

The appraisal that sets every option strike price you will ever grant — how it is built, why the number is always below what investors just paid, and how a stale one turns your best hire's equity into a tax bill.

  • Advanced
  • 8 min total
  • 12 chapters

What decision this helps you make: What strike price you may legally put on an option grant today, and whether your last valuation still supports it.

What this topic is

A 409A valuation is an independent appraisal of a private company's common stock. It produces one number — fair market value per common share — and that number is the floor for the strike price of every option the board grants until the report goes stale.

Why it matters

Grant an option below fair market value and Section 409A treats the discount as deferred compensation. The tax lands on the employee, not the company: income as the option vests, an extra 20% federal tax on top, plus interest — on shares nobody can sell. A correct valuation is also what buys you the safe harbor that puts the burden of proof on the IRS instead of on you.

Who should learn it

Founders and CFOs who sign option grants, board members who approve them, and anyone accepting equity who wants to know where their strike price came from.

What you will understand

  • Why common stock is worth materially less than the preferred price investors just paid
  • The three safe harbors, and what each one actually buys you
  • When a valuation goes stale — the 12-month clock and the material-event rule
  • How to grant options in the gap between a signed term sheet and a fresh report

Prerequisites

Common misconception

"Our 409A says $0.41 a share, but investors just paid $2.00 — the appraiser lowballed us." No. The two numbers measure different securities. Investors bought preferred stock: money back first in a sale, protective vetoes, sometimes a dividend. Employees get common: last in line, no vetoes, no market to sell into. A common share with none of that protection and no liquidity is genuinely worth less than a preferred share issued the same week. The gap is not a favor to employees — it is the price of standing behind everyone else.