INSIGHT

What is a 409A valuation? 

Kemp Moyer • August 15, 2025

Services: Business Valuation

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Private companies face unique challenges when determining the value of their equity, especially when issuing stock options or other equity securities to employees, contractors and service providers. Unlike publicly-traded companies, which have readily available prevailing market prices, private companies must rely on independent appraisals to establish fair market value and fair value in various critical compliance matters. This process becomes critical for tax compliance and protecting stakeholders from IRS penalties, as well as when supporting a financial audit (ASC 718 compliance) and potentially registering with the SEC. 

A 409A valuation serves as the cornerstone of equity compensation planning for private companies, providing the framework for legally compliant stock option programs. This article will explore the fundamentals of 409A valuations, when companies need them, the valuation process and how to select the right provider. 

Understanding 409A valuations 

A 409A valuation represents an independent analysis of a private company’s fair market value, conducted by qualified third-party appraisers. Companies use this valuation to determine the strike price for employee stock options and ensure compliance with Internal Revenue Code Section 409A. Specifically, the analysis ensures that the Company is not underpricing the equity instrument relative to fair market value as of the date of grant, exercise and/or vesting, depending on security type.  

The valuation establishes the per-share value of common stock (or equivalent), which may differ significantly from the preferred stock prices that investors pay during venture equity fundraising rounds. This distinction matters because employees typically receive common stock options, not the preferred shares that carry additional rights and protections. 

“An independent, qualified and accurate 3^rd party valuation will ensure compliance with tax and other regulatory requirements, as well as ensuring fairness for all stakeholders. Considering the importance of equity to any company, it is critical that top management and boards of directors seek well-qualified, hands on, expert support.” – Kemp Moyer – Partner, Advisory 

When companies need 409A valuations 

Companies must obtain 409A valuations before issuing stock options to employees, contractors or advisors, as well as when exercise takes place. Additionally, if restricted stock units (RSUs) or other equivalents are used in a compensation plan, the FMV of the underlying stock is required for reporting at vesting.  

The timing becomes crucial around material events that could affect company value. Fundraising rounds represent the most common material event trigger for new valuation requirements, as they provide clear market data about investor perception of company worth, and often have arms’ length market negotiations, which provide critical evidence to fair market value conclusions. Other material events may include significant customer contracts, acquisitions, strategic partnerships or regulatory changes that impact the business landscape. 

Companies also need more regularly refreshed valuations before major liquidity events like IPOs, mergers or acquisitions. These situations require updated assessments to ensure accurate equity pricing leading up to the transaction process, as value indications can change rapidly and draw additional regulatory scrutiny. 

Valuation validity and refresh requirements 

409A valuations remain valid for a maximum of twelve months from the valuation date, unless a material event occurs sooner. This twelve-month maximum window provides companies with some pricing certainty for their equity programs while ensuring valuations stay reasonably current. 

Material events reset this timeline, requiring companies to obtain updated valuations regardless of when they completed their last analysis. The definition of materiality depends on the specific circumstances but generally includes any event that could materially affect stock price. 

Safe harbor protection 

The IRS provides “safe harbor” status for 409A valuations conducted by independent, qualified appraisers. This protection presumes the valuation is reasonable unless the IRS can prove it’s “grossly unreasonable” – a high standard that provides significant protection for companies and employees. 

Safe harbor status requires meeting specific criteria: the appraiser must be independent and qualified, the valuation must use accepted methodologies and the assessment must occur within twelve months of option grants without intervening material events. 

Consequences of non-compliance 

Companies that fail to obtain proper 409A valuations face severe penalties. Employees receiving mispriced options may owe immediate taxes on all deferred compensation from current and prior years, plus a 20 percent additional tax penalty and accrued interest. 

These penalties apply to employees, not the company, but create significant liability concerns and can damage employee relations and significantly impact key employee morale and retention. The financial impact often far exceeds the cost of obtaining proper valuations, and the business impact of non-compliance can ultimately be substantial, as often the most key employees and top management are covered by an equity plan. 

Valuation methodologies 

Appraisers use three primary approaches when conducting 409A valuations, often combining multiple methods for comprehensive assessments. 

• The market approach compares the company to similar public companies and/or recent transaction data. For companies with recent fundraising, appraisers often employ the option pricing model backsolve method, which uses the preferred stock price as a critical reference point while adjusting and accounting for the rights and preferences differential between preferred and common shares. 
• The income approach focuses on expected future cash flows, discounted to present value based on risk factors. This method works well for companies with established revenue streams and somewhat predictable cash flows. 
• The asset approach or cost approach calculates net asset value, including development of intangible values, as needed, and typically applies to early-stage companies without significant revenue or recent fundraising activity. 

Selecting a valuation provider 

Companies should prioritize providers with relevant experience, proper qualifications and track records of IRS compliance. Qualified appraisers need at least five years of experience in business valuations, financial accounting, investment banking or related fields and should be certified (ASA, CVA, CFA, ABV or equivalent). 

The analysis should be led by an individual who has the requisite experience and use generally accepted valuation methodologies and supportable key assumptions. They must also deliver comprehensive reports that document their analysis and comply with Section 409A guidelines. 

Cost considerations vary widely, depending on company complexity. Some providers offer standalone services while others bundle valuations with cap table management and other services.  

A qualified valuation for 409A purposes should also be qualified to stand up to financial reporting scrutiny under FASB ASC 718 and hold up to SEC standards in the event of a potential public offering or public company acquisition. Should a provider express concern at supporting valuations through ASC 718 review, or indicate the report would not hold up to ASC 718 or SEC scrutiny, it is a red flag.  

Working with BPM  

BPM brings decades of collective experience in 409A valuations across diverse industries and company stages. Our qualified appraisers understand the nuances of private company valuation and maintain current knowledge of IRS requirements and market practices. We work closely with management teams to ensure timely, compliant valuations that support your equity compensation objectives. Our analyses are compliant with FASB guidelines and we have a team that is very comfortable with supporting clients through an SEC process.  

Our comprehensive approach combines technical rigor with practical business understanding, delivering valuations that withstand scrutiny while supporting your growth plans. We recognize that 409A valuations represent more than compliance requirements – they form the foundation of your employee equity programs and long-term value creation strategy. To learn how our team can support your equity compensation planning and ensure IRS compliance, contact us.