409A Valuations for Founders
What a 409A valuation is, when it needs refreshing, and what happens if it comes in too low
by
Teddy Ellison
AI & Data Agreements
Summary
A 409A valuation is an independent appraisal that sets the fair market value of your startup's common stock. You price your stock options at that value or higher. You need one before you grant your first options, and you refresh it after a material event or once it's more than a year old. If the number is stale or too low, the tax penalties fall on the employees holding those options, and the company takes on withholding and reporting exposure of its own.
A startup's common stock doesn't trade on a public market, so there's no price to anchor the strike price on an option you grant. A 409A valuation closes that gap by having a qualified independent firm appraise your common stock and set a fair market value the IRS will accept. Every option you grant then has to be struck at or above that value.
A 409A valuation that has expired, or that a material event has overtaken, stops protecting the grants you price off it. If the strike is below your stock's current fair market value, the IRS can tax the discount as each tranche vests, and again as the stock’s value rises in later years. A key engineer can owe ordinary income on gains they haven't sold and can't reach, with no say in the valuation or the strike that caused it.
For 83(b) elections, how a low or high valuation flows through to your tax basis, and the pre-Series-A cap-table cleanup investors' counsel runs, see SAFEs, 83(b) Elections, and Cap Table Hygiene.
How much does a 409A valuation cost?
Most venture-backed startups pay roughly $2,000 to $5,000 for a 409A, though some cap-table providers bundle it into their subscription at no added fee. Very early companies with a simple cap table often pay less, and later-stage companies with complex capital structures can pay $10,000 or more.
This valuation only protects you if the method behind it holds up. A qualified provider applying one of the IRS safe-harbor methods, with a written analysis that survives an audit, earns the presumption that the value is reasonable. A cut-rate valuation that skips that work can cost far more to defend than it saved.
How often do you need a 409A valuation?
A 409A fixes your company's value on one date, and that figure sets the floor for every option strike price you grant until it expires or is replaced. The safe harbor an appraisal earns lasts 12 months, so even in a quiet year the figure expires and you commission a new one. A material change in what the company is worth ends it sooner.
Any event that materially changes what your common stock is worth can trigger the need for a refreshed valuation. For instance, when you close a priced round, your new investors set a higher price for your preferred stock, and the common-stock figure in your last 409A no longer matches what the company is worth. A secondary sale or employee tender offer above the current number does the same, as does a signed acquisition term sheet or a sharp jump in revenue.
Each of these resets the fair market value of your common stock, which is the figure a 409A is meant to measure. Once a material change or event happens, your last appraisal can no longer support new grants, and you commission a fresh one before the next options are granted.
What happens if your 409A valuation is too low?
A strike comes in too low when it sits below your common stock's fair market value on the grant date. A current 409A from a qualified independent appraiser, dated within 12 months of the grant, usually prevents that, because the number it sets carries a presumption of reasonableness. While that appraisal is current, the IRS can’t overturn the number without proving the method, or its application, was grossly unreasonable.
This protection doesn't last forever. Once the appraisal passes 12 months, or a financing or term sheet overtakes it, the old number stops reflecting what your common stock is worth. New grants priced off it can then fall below fair market value.
An option struck at or above fair market value stays exempt and is taxed under the normal option rules. One struck below it is caught, and the IRS can treat its discount as deferred compensation that fails Section 409A.
Under these circumstances, the tax falls on the person holding the option, not the company that set the price. The holder reports the discount as ordinary income at vesting, then owes tax on any further gains each year until exercise, long before there are shares to sell and cover the bill. Section 409A adds a 20% penalty and interest at a premium rate on top. The company's own exposure is narrower but real. It must withhold and report that income, and may face penalties if it doesn't. Employees hit with a surprise tax bill on their own equity generally don’t take it well.
When do you need a lawyer for a 409A valuation?
For a standard company, you don't need a lawyer to produce the 409A valuation itself, though you will want counsel for the decisions that surround it. The valuation is a financial exercise, run by a specialized appraisal firm or your cap-table provider's valuation team, and your job is to order it on schedule. That means the first valuation before your initial option grant, another after each priced round, or other material events, and once a year if nothing in between. Legal counsel can also help you recognize the events that make a valuation stale and which documents are required for approving a valuation.
The appraisal firm’s job ends at the number, but the same figure plays out differently depending on where you actually are. It can leave a teammate hired abroad on the wrong side of local tax, or need fixing the week before a priced round closes. A lawyer reads the valuation against your real situation and catches the grant that will not survive diligence. Serotonin Legal does this work with founders, before a financing or a sale forces the issue.
Reach out to set up a free consultation.
Serotonin Legal advises technology founders on corporate, regulatory, and transactional matters at the intersection of AI, blockchain, and fintech. This guide is for general informational purposes and does not constitute legal advice. No attorney-client relationship is formed by reading this material.
FAQs
What is a 409A valuation?
A 409A valuation is an independent appraisal that sets the fair market value of a private company's common stock. Startups use it to price stock options, because the strike price has to be at least that fair market value to keep the options outside Section 409A. The name comes from the tax-code section that governs the result.
How long is a 409A valuation good for?
A 409A valuation is generally good for 12 months, though a material event can end its safe harbor protection sooner. If you raise a priced round, receive a financing or acquisition term sheet, or otherwise materially change your value before the year is up, the old appraisal no longer supports new grants. You need a new one before your next grant.
What is the 409A safe harbor?
The 409A safe harbor is a presumption that your stock value is reasonable. With it, the IRS can overturn your number only by showing that the valuation method, or the way it was applied, was grossly unreasonable. Without it, the burden is on you to prove the value was right. Most startups earn it with an independent appraisal dated no more than 12 months before the grant.
The rules also allow a written valuation by a qualified person (generally someone with at least five years of relevant experience) for a company under 10 years old that doesn't expect a sale within 90 days or an IPO within 180 days. A third route, a formula price tied to permanent resale restrictions, is rarely used.
The presumption only covers what the valuation knew. Say your January appraisal sets common stock at $1.00 a share, and in June you sign a Series A term sheet. Options granted in July at $1.00 likely fall outside the safe harbor, even though the appraisal is under 12 months old, because it doesn't reflect the term sheet.
Is a 409A valuation required to grant options?
An independent 409A appraisal isn't a legal requirement, but it is the market standard. The rules require each option's strike price to be at least the stock's fair market value on the grant date, set using a reasonable valuation method. An independent appraisal is the standard way to meet that test because it is the most straightforward route to the safe harbor, which shifts the burden to the IRS to show your number was grossly unreasonable. In other words, investors, auditors, and acquirers' counsel expect to see one.
Alternatively, your board can set fair market value itself through two other generally recognized safe harbor routes: a written valuation by a qualified person for an early-stage company, and a formula price tied to permanent resale restrictions. Each of these carries conditions that are easy to miss, and they are harder to support if the number is ever questioned. Skipping this appraisal to save a few thousand dollars today can lead to much more expensive consequences if a problem arises, including tax bills for your team and a cleanup project in your next financing or sale.
Do you need a 409A valuation for restricted stock?
Restricted stock, including founder stock subject to vesting, falls outside Section 409A because the shares are issued up front instead of promised later. Section 83 governs the tax instead. Fair market value still matters. If the holder pays less than the stock's fair market value, the difference is taxed as ordinary income, either as the shares vest or, with an 83(b) election, at grant. At formation, founders often buy at a nominal price because the company has little value yet.
Once the company has raised money or has real traction, a current 409A is the usual way to support the price. For further information on 83(b) elections, see our prior guide on SAFEs, 83(b) Elections, and Cap Table Hygiene. Restricted stock units are different. An RSU is a promise to deliver shares later, and depending on when it pays out, it can fall under Section 409A.
Curious to learn more about Serotonin Legal? —
Get in Touch
409A Valuations for Founders
What a 409A valuation is, when it needs refreshing, and what happens if it comes in too low
by
Teddy Ellison
AI & Data Agreements
Summary
A 409A valuation is an independent appraisal that sets the fair market value of your startup's common stock. You price your stock options at that value or higher. You need one before you grant your first options, and you refresh it after a material event or once it's more than a year old. If the number is stale or too low, the tax penalties fall on the employees holding those options, and the company takes on withholding and reporting exposure of its own.
A startup's common stock doesn't trade on a public market, so there's no price to anchor the strike price on an option you grant. A 409A valuation closes that gap by having a qualified independent firm appraise your common stock and set a fair market value the IRS will accept. Every option you grant then has to be struck at or above that value.
A 409A valuation that has expired, or that a material event has overtaken, stops protecting the grants you price off it. If the strike is below your stock's current fair market value, the IRS can tax the discount as each tranche vests, and again as the stock’s value rises in later years. A key engineer can owe ordinary income on gains they haven't sold and can't reach, with no say in the valuation or the strike that caused it.
For 83(b) elections, how a low or high valuation flows through to your tax basis, and the pre-Series-A cap-table cleanup investors' counsel runs, see SAFEs, 83(b) Elections, and Cap Table Hygiene.
How much does a 409A valuation cost?
Most venture-backed startups pay roughly $2,000 to $5,000 for a 409A, though some cap-table providers bundle it into their subscription at no added fee. Very early companies with a simple cap table often pay less, and later-stage companies with complex capital structures can pay $10,000 or more.
This valuation only protects you if the method behind it holds up. A qualified provider applying one of the IRS safe-harbor methods, with a written analysis that survives an audit, earns the presumption that the value is reasonable. A cut-rate valuation that skips that work can cost far more to defend than it saved.
How often do you need a 409A valuation?
A 409A fixes your company's value on one date, and that figure sets the floor for every option strike price you grant until it expires or is replaced. The safe harbor an appraisal earns lasts 12 months, so even in a quiet year the figure expires and you commission a new one. A material change in what the company is worth ends it sooner.
Any event that materially changes what your common stock is worth can trigger the need for a refreshed valuation. For instance, when you close a priced round, your new investors set a higher price for your preferred stock, and the common-stock figure in your last 409A no longer matches what the company is worth. A secondary sale or employee tender offer above the current number does the same, as does a signed acquisition term sheet or a sharp jump in revenue.
Each of these resets the fair market value of your common stock, which is the figure a 409A is meant to measure. Once a material change or event happens, your last appraisal can no longer support new grants, and you commission a fresh one before the next options are granted.
What happens if your 409A valuation is too low?
A strike comes in too low when it sits below your common stock's fair market value on the grant date. A current 409A from a qualified independent appraiser, dated within 12 months of the grant, usually prevents that, because the number it sets carries a presumption of reasonableness. While that appraisal is current, the IRS can’t overturn the number without proving the method, or its application, was grossly unreasonable.
This protection doesn't last forever. Once the appraisal passes 12 months, or a financing or term sheet overtakes it, the old number stops reflecting what your common stock is worth. New grants priced off it can then fall below fair market value.
An option struck at or above fair market value stays exempt and is taxed under the normal option rules. One struck below it is caught, and the IRS can treat its discount as deferred compensation that fails Section 409A.
Under these circumstances, the tax falls on the person holding the option, not the company that set the price. The holder reports the discount as ordinary income at vesting, then owes tax on any further gains each year until exercise, long before there are shares to sell and cover the bill. Section 409A adds a 20% penalty and interest at a premium rate on top. The company's own exposure is narrower but real. It must withhold and report that income, and may face penalties if it doesn't. Employees hit with a surprise tax bill on their own equity generally don’t take it well.
When do you need a lawyer for a 409A valuation?
For a standard company, you don't need a lawyer to produce the 409A valuation itself, though you will want counsel for the decisions that surround it. The valuation is a financial exercise, run by a specialized appraisal firm or your cap-table provider's valuation team, and your job is to order it on schedule. That means the first valuation before your initial option grant, another after each priced round, or other material events, and once a year if nothing in between. Legal counsel can also help you recognize the events that make a valuation stale and which documents are required for approving a valuation.
The appraisal firm’s job ends at the number, but the same figure plays out differently depending on where you actually are. It can leave a teammate hired abroad on the wrong side of local tax, or need fixing the week before a priced round closes. A lawyer reads the valuation against your real situation and catches the grant that will not survive diligence. Serotonin Legal does this work with founders, before a financing or a sale forces the issue.
Reach out to set up a free consultation.
Serotonin Legal advises technology founders on corporate, regulatory, and transactional matters at the intersection of AI, blockchain, and fintech. This guide is for general informational purposes and does not constitute legal advice. No attorney-client relationship is formed by reading this material.
FAQs
What is a 409A valuation?
A 409A valuation is an independent appraisal that sets the fair market value of a private company's common stock. Startups use it to price stock options, because the strike price has to be at least that fair market value to keep the options outside Section 409A. The name comes from the tax-code section that governs the result.
How long is a 409A valuation good for?
A 409A valuation is generally good for 12 months, though a material event can end its safe harbor protection sooner. If you raise a priced round, receive a financing or acquisition term sheet, or otherwise materially change your value before the year is up, the old appraisal no longer supports new grants. You need a new one before your next grant.
What is the 409A safe harbor?
The 409A safe harbor is a presumption that your stock value is reasonable. With it, the IRS can overturn your number only by showing that the valuation method, or the way it was applied, was grossly unreasonable. Without it, the burden is on you to prove the value was right. Most startups earn it with an independent appraisal dated no more than 12 months before the grant.
The rules also allow a written valuation by a qualified person (generally someone with at least five years of relevant experience) for a company under 10 years old that doesn't expect a sale within 90 days or an IPO within 180 days. A third route, a formula price tied to permanent resale restrictions, is rarely used.
The presumption only covers what the valuation knew. Say your January appraisal sets common stock at $1.00 a share, and in June you sign a Series A term sheet. Options granted in July at $1.00 likely fall outside the safe harbor, even though the appraisal is under 12 months old, because it doesn't reflect the term sheet.
Is a 409A valuation required to grant options?
An independent 409A appraisal isn't a legal requirement, but it is the market standard. The rules require each option's strike price to be at least the stock's fair market value on the grant date, set using a reasonable valuation method. An independent appraisal is the standard way to meet that test because it is the most straightforward route to the safe harbor, which shifts the burden to the IRS to show your number was grossly unreasonable. In other words, investors, auditors, and acquirers' counsel expect to see one.
Alternatively, your board can set fair market value itself through two other generally recognized safe harbor routes: a written valuation by a qualified person for an early-stage company, and a formula price tied to permanent resale restrictions. Each of these carries conditions that are easy to miss, and they are harder to support if the number is ever questioned. Skipping this appraisal to save a few thousand dollars today can lead to much more expensive consequences if a problem arises, including tax bills for your team and a cleanup project in your next financing or sale.
Do you need a 409A valuation for restricted stock?
Restricted stock, including founder stock subject to vesting, falls outside Section 409A because the shares are issued up front instead of promised later. Section 83 governs the tax instead. Fair market value still matters. If the holder pays less than the stock's fair market value, the difference is taxed as ordinary income, either as the shares vest or, with an 83(b) election, at grant. At formation, founders often buy at a nominal price because the company has little value yet.
Once the company has raised money or has real traction, a current 409A is the usual way to support the price. For further information on 83(b) elections, see our prior guide on SAFEs, 83(b) Elections, and Cap Table Hygiene. Restricted stock units are different. An RSU is a promise to deliver shares later, and depending on when it pays out, it can fall under Section 409A.
Curious to learn more about Serotonin Legal?
Get in Touch
