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If you’re a founder planning to raise capital from sophisticated investors—such as venture capital firms—you will almost certainly need a company valuation at some point. Startups obtain valuations for different reasons, and one of the most common (and reliable) is a 409A valuation.
A 409A valuation is an independent appraisal of the fair market value (FMV) of a private company’s common shares. It is most often required when a startup issues stock options to employees, since every option grant must have a defensible exercise price (also known as the “strike price”).
The term “409A” comes from Section 409A of the U.S. Internal Revenue Code, which governs how equity-based compensation is valued for tax purposes. The stakes are high: if a 409A valuation is missing or done incorrectly, employees may face significant tax penalties. Beyond the IRS, investors will also expect to see a valid 409A during due diligence. Option grants priced improperly can raise red flags and, in some cases, jeopardize an investment.
Do I Need a 409A Valuation Done?
For early-stage startups, equity is one of the most powerful tools for attracting and retaining talent. Early employees take real risk and quickly accumulate critical institutional knowledge. Granting equity aligns incentives and rewards them for helping build the company—but doing so properly requires a 409A valuation from the outset.
You will also need an updated 409A when a material event occurs that could affect the company’s value. Common examples include:
· A significant change to the business model
· Gaining or losing a major customer
· A new financing round
· An unsolicited acquisition offer
Even if you are not actively issuing stock options and no material events have occurred, it is considered best practice to obtain a new 409A valuation annually.
409A Safe Harbours
“409A safe harbour” status protects both the company and its equity holders if the IRS ever audits the valuation. Safe harbour creates a presumption that the option exercise price was reasonable and IRS-compliant—saving founders and employees from major headaches.
Without safe harbour protection, employees could be hit with unexpected taxes and penalties, turning what should be a meaningful incentive into a financial burden.
To qualify for safe harbour, a 409A valuation must meet the following IRS requirements:
1. Be conducted by an independent appraiser (at arm’s length from the company)
2. Be prepared by a qualified appraiser
3. Be current (generally less than 12 months old and updated after any material event)
4. Be documented in writing, with a clear explanation of the valuation methodology
Main Takeaways
First, always obtain a formal valuation before issuing equity to employees.
Second, keep that valuation up to date to avoid serious tax consequences.
Third, ensure the valuation is completed by a qualified, independent appraiser.
When done correctly, a 409A valuation protects your team, satisfies investor expectations, and ensures employees can fully benefit from their equity as your company grows.
At Apex Corporate Law, we regularly guide founders through the valuation process and the equity issuances that follow, helping ensure compliance while supporting long-term growth.
