409A Valuation

Quick Definition

An independent appraisal of a private company's common stock fair market value, required for issuing stock options.

What is a 409A Valuation?

A 409A valuation is an independent assessment of your company's common stock fair market value. Named after IRS Section 409A, it determines the minimum price at which you can grant stock options without triggering tax penalties for employees.

Why 409A Valuation Matters

If you grant options below fair market value, employees face immediate income tax on the discount plus a 20% penalty. A proper 409A provides "safe harbor" protection against these penalties.

For SaaS founders, your 409A value is typically much lower than your preferred stock price because common stock lacks the liquidation preferences and other protections investors receive. This discount benefits employees receiving options.

409A Timing and Updates

Get a 409A before issuing any options. Update it annually or after material events: raising a round, significant revenue changes, or major business developments. Stale 409As create risk.

Formula

409A providers use multiple methods:

• Income Approach: Discounted cash flow of future earnings
• Market Approach: Comparable company multiples
• Asset Approach: Net asset value

Results are weighted to determine FMV.

Example

Your SaaS company raises Series A:

• Series A Price: $5.00 per preferred share
• 409A Valuation: $1.25 per common share
• Discount: 75% (typical range: 60-85%)

You can grant options with a $1.25 strike price, giving employees significant upside. If you granted at $0.50 without a 409A, employees would face tax penalties on the $0.75 "discount" from FMV.

Related Terms

Exercise Price (Strike Price)

The price an option holder pays to convert options into shares, set at fair market value when granted.
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Option Pool

A percentage of company equity reserved for future employee stock option grants, typically 10-20% of fully diluted shares.
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Common Stock

Basic ownership shares with voting rights but no special preferences, typically held by founders and employees.
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