409A valuations: what they are and why you need one before granting options
By Corply · Updated
A 409A valuation sets the fair market value of your common stock. Grant options at or above it and your team avoids a tax problem that falls on them, not the company.
1. The tax rule behind the number
What Section 409A says about options
Section 409A of the Internal Revenue Code governs deferred compensation. A stock option escapes it only if its exercise price is at least the fair market value of the underlying stock on the grant date. Price an option below that value and it becomes deferred compensation.
The consequences land on the option holder. If an option fails Section 409A, the holder can owe income tax as the option vests rather than when they exercise or sell, plus an additional 20% federal tax and interest. A discounted grant can turn a recruiting tool into a tax bill for the people you hired.
What a 409A valuation is
A 409A valuation is a report that estimates the fair market value of one share of your common stock. It is usually prepared by an independent appraiser using the company's financials, recent financings, outstanding securities and comparable companies. Common stock usually values below the preferred stock investors buy, because preferred carries rights common does not.
2. The safe harbors
The Treasury regulations describe valuation methods that are presumed reasonable. If you use one, the IRS can overturn the value only by showing it was grossly unreasonable. Without one, the burden is on the company to defend its number.
| Safe harbor | In short |
|---|---|
| Independent appraisal | A qualified independent appraiser values the stock as of a date no more than 12 months before the grant |
| Illiquid startup | A written valuation by someone with significant relevant experience, for a company under 10 years old with no expected sale within 90 days or IPO within 180 days |
| Binding formula | A formula price that also applies to every transfer of the stock, used consistently |
Most venture-backed startups use an independent appraisal because it is the most widely accepted. The value it sets is the floor for every option the board grants until the valuation goes stale.
3. How long a 409A lasts
An independent appraisal can support grants for up to 12 months from its valuation date, but only while nothing material changes. Events that commonly call for a new valuation include:
- A priced equity financing, or a SAFE round that changes the company's value.
- A large change in revenue, contracts or the business plan.
- An acquisition offer or a sale process.
- Twelve months passing since the valuation date.
SAFEs deserve a note. They do not set a price per share, but a round of them is still evidence of what investors will pay, and many appraisers treat a significant SAFE raise as a reason to refresh. Ask your appraiser before granting options after you raise.
4. Using it in practice
- Before the first grant. Get a valuation before the board grants any options. Founders' own restricted stock, bought at formation for a nominal price, is a different transaction.
- At each grant. The board consent states the exercise price, at or above the current 409A value, and the valuation it relies on.
- Keep the report. Store the valuation report and its date with the grant records. An acquirer's lawyers will ask for both.
Ask Corply: “Show the valuation behind each option grant and flag any grant made after a financing without a newer valuation.”
Corply does not prepare 409A valuations. It keeps the report you receive with the company's equity records, so each grant can be traced to the value it relied on.
5. Common questions
Do I need a 409A to issue founder stock?
Not usually. Founders typically buy restricted stock at formation for a nominal price, before the company has meaningful value. The 409A rule matters most for stock options, whose exercise price must be at least fair market value on the grant date.
Who pays the penalty if a grant is priced too low?
Primarily the option holder, who can owe income tax as the option vests, an additional 20% federal tax and interest. The company can also face withholding and reporting problems.
Does raising SAFEs require a new 409A?
Not automatically, but a SAFE round is often treated as a material event. Ask your appraiser before granting more options after you raise.
Is the 409A value what my company is worth?
No. It is the fair market value of one share of common stock for tax purposes. Investors' preferred price and the company's total valuation are different numbers.
This page is general education, not legal or tax advice, and reading it does not create an attorney-client relationship. Corply is operated by 0Lumen Labs Corp., is not a law firm, and routes questions that need individualized judgment to licensed professionals. Rules and fees change, so verify current requirements with the relevant state, the IRS, or your counsel.