What is a 409A Valuation? Why Does a 409A Valuation Matter?
Why Does a 409A Valuation Matter?
What Is A 409A Valuation Safe Harbor and Why Is It Important?
When Do You Need a 409A Valuation?
What Happens if Your 409A Valuation is Incorrect?
How to Choose the Right 409A Provider
Why is a Third-Party 409A Valuation Provider a Strategic Advantage?
What is a 409A Valuation?
A 409A valuation is a method used to determine the fair market value (FMV) of a private company’s stock. The 409A valuation uses this private company stock valuation to set the price at which employees can purchase their stock options.
A 409A valuation is required under Internal Revenue Code Section 409A (IRC 409A, as part of the American Jobs Creation Act) for any private company issuing equity compensation, like stock options or RSUs to employees or advisors. The 409A valuation ensures that the strike price (also known as the exercise price) of a stock offered to employees is at or above fair market value (FMV).
(It’s important to note: A 409A valuation applies to stock options, not restricted stock, and if the grantee owns 10% or more of the company, like a founder who receives option grants over and above his or her founder shares, the stock must be issued at 110% of fair market value.)
Why Does a 409A Valuation Matter?
A 409A valuation for startups is extremely important for:
- IRS Compliance
- Audit-Readiness
- Equity Compensation
- Investor and Board Confidence
Ensuring compliance with the IRS, a 409A valuation help protect employees and the company alike from unexpected, steep tax liabilities or legal fees by preventing taxation on gains at the incorrect time.
A 409A valuation provides thorough documentation to establish the FMV of a company’s stock, which—if conducted using IRS-approved methods—can qualify for safe harbor status. This status can help demonstrate compliance with IRS regulations and protects against potential tax penalties.
A 409A valuation is also critical for equity compensation, especially at a startup. By legally granting stock options at FMV, it can attract talent and incentivize employee retention, as stock options often serve as an appealing recruiting tool.
A 409A valuation for startups can also inspire confidence on behalf of your board, investors, and potential investors. Since the IRS 409A requirements are stringent, a 409A valuation at your startup adds rigor and transparency during internal valuation and fundraising rounds
What Is A 409A Valuation Safe Harbor and Why Is It Important?
A 409A valuation safe harbor is a status granted when a company follows specific IRS guidelines to determine the fair market value (FMV) of its common stock. When these rules are followed, the IRS presumes the valuation is reasonable.
To qualify for safe harbor, the valuation must be conducted by a qualified, independent third party using IRS-approved methods—typically the market approach, income approach, or asset approach. The valuation must also be updated at least every 12 months, or sooner if a material event occurs, such as a merger or acquisition.
Achieving 409A safe harbor status benefits both startups and established companies. It shifts the burden of proof to the IRS in the event of an audit, offering protection to the company, its employees, and its board. Essentially, it signals that the FMV has been determined in good faith and in compliance with IRS standards.
To support companies in achieving and maintaining 409A safe harbor status, Fidelity Private Shares connects you with trusted valuation providers and ensures audit-ready documentation is maintained across all grant cycles.
When Do You Need a 409A Valuation?
There are three major instances when you should have a 409A valuation.
- First-time grants, or grants issued before your employee or investor stock options, require a 409A valuation. The 409A valuation can ensure the employee is granted a transparent, fair view of their equity and helps protect from unexpected tax burdens when they choose to purchase shares.
- A 409A valuation for startups is also needed annually, or every 12 months, as it will ensure your startup's stock FMV meets IRS requirements. This annual 409A valuation can help make your startup both audit-ready and less likely to be audited.
- It’s also important for a 409A valuation to occur after any sort of material event. These events include a new fundraising round, mergers and acquisitions (M&A), any kind of business model pivot, or with significant revenue growth or profitability spikes and drops.
409A Valuation Methods
After gathering the necessary documentation, the next step in the 409A valuation process is selecting the appropriate valuation method. A qualified third-party provider will choose the method based on your company’s stage, size, financial profile, and available data. There are three primary IRS-approved approaches:
- Market Approach: This method compares your company to similar public or recently acquired private companies. It uses valuation multiples (like revenue or EBITDA) to estimate your fair market value (FMV). It’s often used when there are relevant comps or recent financing rounds.
- Income Approach: Best suited for companies with predictable revenue and cash flow, this method forecasts future earnings and discounts them to present value. It requires solid financial projections and is more common in later-stage startups.
- Asset Approach: This method values the company based on its net assets—total assets minus liabilities. It’s typically used for very early-stage startups with limited revenue or for companies preparing for liquidation.
It’s important to note that any of these three methods can be used to create a 409A safe harbor for your startup.
But no matter the method used for your 409A evaluation, the amount of common stock and preferred stock will be taken into consideration when determining your FMV. So, what’s the difference between the two? Common stock shareholders are paid last if a company liquidates, even after creditors. Common stock is considered riskier, or more volatile, than preferred. Common stock shareholders often have voting rights, while preferred stock shareholders do not. Another difference between the two? Preferred stock shareholders are paid dividends before common stock shareholders and are paid first if your company is liquidated.
Interested in diving even deeper into 409A Valuations for startups? Download the 409A Valuation Guide here.
What Happens If Your 409A Valuation is Incorrect?
If a startup mishandles its 409A valuation, employees can face serious tax consequences. An incorrect valuation may cause stock options to be considered deferred compensation that doesn’t comply with IRS rules. As a result, employees could be taxed immediately on the value of their vested options, even if they haven’t exercised them. In addition to regular income tax, the IRS can impose a penalty tax and may apply interest and other penalties. These consequences apply to the affected portion of the plan and can recur annually if the issue isn’t corrected.
Beyond the financial tax implications, there’s the issue of legal exposure, as liabilities like back taxes or an IRS audit can unearth even more issues.
Dilution errors, or mispriced equity options / FMV, may also result in inaccurate cap tables and overcompensation for employees, which can also create tax and legal burden on the company down the line. Then there’s the damaged trust a bungled 409A valuation creates within the company, as well as the erosion of trust from investors and during future fundraising rounds.
If you realize your 409A valuation was done incorrectly, don’t panic—but act fast. Consider hiring a reputable valuation firm to redo the report properly. Make sure they understand your business model, cap table, and any recent changes. Keep good records and document everything. If the mistake is caught early, the IRS has correction programs that might reduce or eliminate penalties. Going forward, consider setting a reminder to update your 409A at least once a year or whenever there’s a major event like a funding round or acquisition offer.
How to Choose the Right 409A Provider
We believe the right 409A provider will provide an industry-vetted, streamlined process to the 409A valuation that is fast, accurate, and competitively priced.
There are several key components to look for when choosing a 409A valuation provider, beginning with deep startup and venture financing experience. No matter what stage or size your company is, you want to choose a 409A valuation provider that offers expertise for every level, so as your startup grows, the 409A valuation provider can scale with you.
An optimal 409A provider should also offer IRS audit support and ensure your valuations are always organized, well-documented, and audit-ready. Be sure to look for seamless, automatic data integrations, like cap table tools, so your paper and digital trail is always accurate.
Fidelity Private Shares is a 409A valuation provider that offers a single platform to help startups manage their valuations, grants, and cap table insights, from day one to the present. With support across multiple funding rounds and corporate milestones, Fidelity Private Shares offers scalability from seed through late-stage growth and 409A valuation workflows that can grow alongside your startup.
Why is a Third-Party 409A Valuation Provider a Strategic Advantage?
Using a third-party 409A valuation is a smart choice for startups and established companies alike. While many companies want to conduct their own in-house 409A valuations, in-house practices often fall short of IRS safe harbor standards and are more likely to fall victim to mistakes from outdated data, like an outdated cap table, outdated methods, or incomplete documentation.
Internal 409A valuations can also disqualify 409A safe harbor status, as they lack the independence of a third party provider. This same logic applies to why 409A valuations conducted internally are harder to defend in audits, due diligence, or fundraising rounds. There’s no outside force to fact-check or ensure accuracy. Finally, in-house 409A valuations can add more burden onto already strapped internal teams, especially at busy startups.
Without the correct valuation expertise or time, even the most well-meaning team members might mishandle a 409A valuation.
Using a qualified third-party can bring credibility, consistency, and less risk to your 409A valuation process, especially as your company scales. IRS 409A safe harbor requirements can be met with more confidence and overall risk is lowered during audits, future 409A valuation and fundraising, or exits.
Fidelity Private Shares connects you with trusted and independent valuation providers that use clean, connected data from your automatically updated cap table to provide private company stock valuation. By maintaining audit-ready documentation across grant cycles, your team can experience less internal burden and risk with a streamlined workflow during the 409A valuation process.
How Fidelity Private Shares 409A Valuation Works
Fidelity Private Shares offers a 409A valuation process to help determine your startup’s fair market value (FMV).
Fidelity Private Shares centralizes the full 409A workflow:
- Integrated forms: Instead of emailing documents, you can respond to structured questions about financials, the team, legal matters, etc.
- Document upload: Upload all required files (e.g., cap table, charters, legal agreements) directly in-platform.
- Valuation provider integration: Fidelity Private Shares passes your materials seamlessly and securely to the third-party provider.
Many competitors use methodologies and data sets that lead to valuations that may not stand up to auditor scrutiny. We connect you with third party 409A Valuation Report providers based on your company’s individual needs. The independent valuations come with access to the valuation expert.
The bottom line? A 409A valuation is more than compliance. A 409A valuation is a pillar of your company’s compensation strategy. Fidelity Private Shares supports your startup with valuation-ready equity data, connected provider access, and streamlined grant management.
Learn how Fidelity Private Shares can help you stay compliant and equity-confident from day one.
409a valuations are conducted by a third party.
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