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5 Things Your company Needs To Know About 409A Valuation

Is your company planning to offer stock options to employees? Then getting a 409A valuation is Primordial

Today, it's day 76 of my next company adventure. And I've got stock options on my mind.

company stock options

What is the reason?

Because if the boss is willing to offer stock options to employees or contractors , then you ought to get a 409A valuation.

Did you hear of 409A valuation? if not no worries, in this article I'll explain it to you step by step.

Here are Five things you have to know about a 409A valuation.

1. What 409A Valuation stands for ?

In essence, the 409A valuation is an assessment of the fair market value of the company's common stock. For publicly traded stocks, it is easy to determine the price at any given time of the day. 

But if it is a private company stock, you will need an independent valuation to assess the value of your company's stock.

The name 409A comes from Section 409A of the IRS. As part of the U.S. Job Creation Act of 2004, it stated: Section 409A applies to compensation received by an employee within one year, but will be paid in the previous year. This is called deferred compensation for failure. 

This is different from deferred compensation that is selectively deferred to eligible plans (such as 401(k) plans) or 403(b) or 457(b) plans. Stock options are considered deferred compensation. 

The 409A valuation will determine the "strike price" (the price at which employees can purchase equity in the company) that must be equal to or higher than the fair market value.

2. What is the reason that a 409A Valuation is necessary?

Simply, because a 409A valuation is legitimately. You need a 409A valuation to ensure your company is in compliance.

Non-compliance can have bas consequences. Undervaluing stock options can result in major IRS penalties and lost compensation.

3. When Do You Need a 409A Valuation?

If you intend to offer common stock options, then you must obtain a 409A valuation twice.

Every 12 months.

Anytime your company closes a new funding round.

4. What Factors Influence Your 409A Valuation?

Essentially, 409A is an assessment. To determine this, companies usually use one of the following methods to assess fair market value: 

  • Market approach: analysis of comparable private and listed companies and transactions. 

  • Income method: Analyze the company's free cash flow to determine the forecast for the next five years. 

  • Asset method: analysis of the company's tangible and intangible assets.

5. How Do You Get a 409A Valuation?

You have three options to get a 409A valuation report:

  • Do it by yourself. This is the riskiest option among the three, because if the IRS intervenes, there will be no "safe harbor" protection. This means you must prove that your valuation is correct. Although you may save money by doing it yourself, you may also make mistakes. Unless you have the professional knowledge and education required to perform 409A, please refer it to a professional. 

  • use the software. This is also risky. Only certain early-stage startups are eligible to do this (for example, you have no stable income, you have not raised $500,000, you have not made an IPO within 180 days or an acquisition within 90 days, your Funds less than 100,000 USD in assets).

  • Hiring a company. Purchasing 409A is the least risky option because it provides safe harbor protection. This means that the burden of proof is now on the IRS (not you) to prove that your valuation is too low. You need to find an independent company that is knowledgeable, experienced, well-educated, and has a good reputation.

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