Legal & Equity
409A Valuation
409A Valuation is an independent appraisal of a private company's common stock fair market value, named after IRS Section 409A. It sets the minimum legal strike price for stock options you grant to employees so those grants are not treated as deferred compensation and hit with penalty taxes.
Also known as: 409A, fair market value appraisal, common stock valuation
Why it matters
If you are pre-revenue and just deciding what to build, a 409A is not your problem yet. It becomes your problem the moment you incorporate a C-corp, raise priced money, and want to hand out option grants to lure early hires. The 409A is what lets you grant cheap options legally: a low common stock price (often 20 to 40 percent of the preferred price right after a round) means employees buy in low and the upside is real, which is the whole point of equity comp at a startup that cannot pay market salaries. Get it wrong and the IRS can deem the discount as taxable income immediately, plus a 20 percent federal penalty, which torches the goodwill you were trying to build. From a build-or-kill lens it is a downstream cost of the venture path: if your validation says you are bootstrapping or staying a one-person shop, you can skip the expense entirely. If your plan needs a team and VC money, budget for it as a recurring chore (roughly 1k to 5k per year, refreshed every 12 months or after any material event).
Worked example
You raise a seed round at a 10M post-money valuation with preferred shares priced at 1.00 each. Your 409A provider appraises common stock at 0.30 per share because common sits below preferred in liquidation. You grant a new engineer options with a 0.30 strike. If common doubles to 0.60 by exercise, the engineer captures the spread legally. Had you set the strike at 0.10 to look generous, the IRS could treat the 0.20 discount as deferred comp and tax it on the spot.
Common mistakes
- Skipping the 409A and pulling a strike price out of thin air. Without an independent appraisal you lose the safe harbor, and the burden shifts to you to prove the price was reasonable if the IRS asks.
- Letting the valuation go stale. A 409A is valid for 12 months or until a material event (new round, acquisition offer, big revenue change). Granting options on an expired appraisal voids the safe harbor.
- Confusing your 409A with your investor valuation. The 409A common stock price is intentionally lower than the post-money preferred price, and pushing it artificially high just to brag inflates option strikes and kills the recruiting upside.
Frequently asked questions
What is a 409A valuation and who needs one?
It is a third-party appraisal of your private company's common stock, required so you can grant stock options at a defensible strike price. Any C-corp that issues options to employees or contractors needs one, typically starting right after the first priced round. If you have not incorporated or have no employees getting equity, you do not need one yet.
How much does a 409A valuation cost?
Most early-stage startups pay between 1,000 and 5,000 dollars per appraisal, and many cap-table platforms bundle it into their subscription for low hundreds or free. Cost rises with company complexity, revenue, and the number of share classes. Budget for one refresh per year plus extras after any material event like a new round.
How is a 409A valuation different from a post-money valuation?
Post-money is what investors pay for preferred shares and signals market hype. The 409A appraises common stock, which sits below preferred in liquidation preference and carries no investor protections, so it lands much lower. Right after a round the 409A common price is often only 20 to 40 percent of the preferred price.
How often do I need to update my 409A valuation?
At least every 12 months, and immediately after any material event such as a new financing round, a significant revenue shift, an acquisition offer, or a major product launch. Granting options on an expired or stale appraisal forfeits the IRS safe harbor. Treat it as a recurring compliance task, not a one-time purchase.
What happens if I set the option strike price too low?
If the strike is below the appraised fair market value, the IRS can treat that discount as deferred compensation under Section 409A. The employee owes ordinary income tax on the spread as it vests, plus a 20 percent federal penalty and possible interest. This punishes the very people you were trying to reward, so a clean appraisal protects everyone.
Do I need a 409A valuation if I am bootstrapping?
Not unless you are a C-corp granting stock options. A solo founder or an LLC with no option grants has nothing to appraise for 409A purposes. If your validation points to bootstrapping and a small team paid in cash or profit share, you can skip the cost entirely until equity comp enters the picture.
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Last updated 2026-06-09 · Back to the glossary