{"id":1361,"date":"2019-05-24T00:00:00","date_gmt":"2019-05-24T00:00:00","guid":{"rendered":"http:\/\/www-staging.carta.com\/sg\/blog\/409a-valuations-for-founders\/"},"modified":"2021-03-05T06:57:41","modified_gmt":"2021-03-05T06:57:41","slug":"409a-valuations-for-founders","status":"publish","type":"post","link":"https:\/\/www-staging.carta.com\/sg\/blog\/409a-valuations-for-founders\/","title":{"rendered":"What every founder needs to know about 409A valuations"},"content":{"rendered":"\r\n

Compliance and 409A valuations<\/a> aren\u2019t the most exciting parts of being a founder, but they\u2019re critical to a company\u2019s long-term success. Here, we\u2019ll explain what a 409A <\/a>valuation is, how often you\u2019ll need to go through the process, and more. You can also download a sample 409A report<\/a> to get a general idea of what a 409A looks like.<\/p>\r\n\r\n\r\n\r\n

409A valuations determine the fair market value of common stock<\/strong><\/h3>\r\n\r\n\r\n\r\n

First, it\u2019s important to distinguish between a 409A valuation and a valuation set by investors during fundraising.<\/p>\r\n\r\n\r\n\r\n

A 409A is used to determine the fair market value (FMV)<\/a> of your company\u2019s common stock<\/a> and is typically determined by a third-party valuation provider. 409As set the strike price for options issued to employees, contractors, advisors, and anyone else who gets common stock.<\/p>\r\n\r\n\r\n\r\n

A 409A valuation is often (but not always) different from a company\u2019s post-money valuation<\/a>, which is based on how much investors paid for their ownership stake during a fundraising. Investors get preferred stock<\/a>, so a post-money valuation is based on the price of preferred shares, whereas a 409A is a valuation of your common stock. Preferred stock usually has certain attributes that make it more valuable than common stock.<\/p>\r\n\r\n\r\n\r\n

409As, which refer to the Internal Revenue Code Section 409A, are regulated by the IRS<\/a>. To take advantage of the IRS safe harbor (i.e. not be subject to certain IRS penalties), 409A valuations should be done annually or each time the company has a material event, like a new financing.<\/p>\r\n\r\n\r\n\r\n

The 409A safe harbor may protect you from certain IRS penalties
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While companies often run their own financial analysis to determine FMV very early on in the company\u2019s lifecycle, with time, those valuations become more difficult, require more expertise<\/a>, and take more time. Third-party, independent valuation providers like Carta can help make sure you have a 409A on file, which may protect common shareholders from certain IRS penalties.<\/p>\r\n\r\n\r\n\r\n

To take advantage of IRS safe harbor in the context of 409A valuations, your company should have completed an acceptable 409A valuation in the last 12 months. If you haven\u2019t, or if the IRS determines that your valuation is grossly unreasonable (and therefore your option grants were not issued at fair market value), option-holders could be impacted.<\/p>\r\n\r\n\r\n\r\n

Here\u2019s what could happen to the employees who received incorrectly priced options:<\/p>\r\n\r\n\r\n\r\n