ARTICLE (dictionary_terms)
What it is
A 409A valuation is an appraisal used to establish the fair market value (FMV) of a US company's common stock. That FMV becomes the minimum strike price for stock options you grant.
Facts
- Named after Section 409A of the US Internal Revenue Code.
- Options must be granted with a strike price at or above the 409A FMV to avoid harsh tax penalties.
- A 409A is valid for 12 months or until a material event (like a new priced round), whichever comes first.
- Common stock FMV is typically well below the preferred price investors paid.
Who it's for
US C corporations that grant stock options to employees and must establish FMV before issuing options.
How it helps you
A defensible independent 409A can give you safe harbor, shifting the burden to the IRS to disprove your valuation, and lets you grant options with low strike prices legally.
Caveats
Don't skip establishing FMV or set it without adequate support. Options granted below FMV can trigger taxation plus a 20% penalty for employees when they vest or otherwise become taxable. Refresh the valuation after each priced round.
Conclusion
Establishing FMV is a compliance requirement before granting US stock options. An independent 409A valuation from a qualified provider can provide safe harbor protection and should be refreshed after material events.
