409A Valuation

A 409A valuation is a formal, independent assessment of the fair market value (FMV) of your company's common stock. It's named after Section 409A of the Internal Revenue Code, which requires that stock options be granted at or above the stock's FMV to avoid severe tax penalties. In plain terms: before you can grant stock options to employees, you need an outside expert to tell you what your common stock is actually worth.

For early-stage startups, the 409A value is typically much lower than the preferred stock price investors paid in your last round. That's because preferred stock has rights that common stock doesn't — liquidation preferences, anti-dilution protections, board seats. A 409A valuation might peg your common stock at 20-40% of the preferred price, depending on the company's stage and the specific rights attached to each share class.

You need a new 409A valuation at least every 12 months, or whenever a "material event" occurs (like closing a funding round, significant revenue changes, or pivoting the business). Most startups use third-party valuation firms (Carta, Eqvista, Scalar) that charge $1K-$5K per appraisal. The resulting report provides "safe harbor" protection — meaning the IRS will generally accept the valuation as reasonable, protecting both the company and its employees from tax problems.

If you're granting stock options — and virtually every venture-backed startup does — a 409A valuation isn't optional. Setting your exercise price below FMV triggers Section 409A penalties for the option recipient: immediate taxation plus a 20% penalty tax. Getting a proper 409A valuation before your first option grants, and keeping it current, protects your employees and your company. It's also required to complete a priced equity round — investors will ask for it during due diligence.