If you're a startup founder, you might have heard of a 409A valuation but may not be sure whether your company needs one. This article starts with a simple checklist to help you determine if a 409A valuation is necessary and provides insights into the process, including when and why it might be beneficial.
What is a 409A Valuation?
A 409A valuation is an independent appraisal of a private company's common stock fair market value (FMV). It's named after Section 409A of the U.S. Internal Revenue Code and is crucial for companies offering equity compensation to employees, especially those with U.S. tax obligations.
409A Valuation Checklist for Startup Founders
Use the following questions to evaluate whether a 409A valuation is required for your startup:
Do you plan to offer equity to employees or advisors who are US citizens?
If yes: A 409A valuation is required.
Is your last 409A valuation more than 12 months old?
If yes: A new 409A valuation is needed.
Have you experienced a material change in your business?
If yes: It is recommended that you update any existing 409a valuation.
Are you approaching a liquidity event (e.g., IPO, M&A)?
If yes: A 409A valuation is strongly recommended.
Do you have a complicated cap table with various share classes?
If yes: A 409A valuation is recommended.
If you are unsure, speak to a qualified advisor.
When Can You ‘Do it Yourself’?
If you answered "No" to most of the checklist questions, your startup might be able to calculate a valuation yourselves, typically if the following conditions are all true:
Your company is very early stage.
You haven't raised significant funding to date (e.g. only convertible notes or SAFEs).
You are calculating a valuation in anticipation of a funding round, to aid negotiations.
You have a relatively simple cap table.
It’s crucial to document your approach thoroughly and ensure your assumptions are reasonable. One way to help ensure that is to use a platform like Equidam, which provides a 25+ page report that documents all inputs, parameters and calculations clearly — as well as clear benchmarks for valuation and financials.
What Is a Material Change That Triggers a 409A Valuation?
A material change is any significant event that could substantially affect your company’s valuation. Examples include:
Financial Changes
Equity Financing: Completion of a seed round, Series A, or beyond.
Revenue Swings: Sharp increases due to new contracts or significant losses.
Debt Restructuring or Issuance: Including convertible notes with valuation caps or discounts.
Corporate Events
Mergers and Acquisitions: Sale of major assets or the company itself.
IPO Preparation: Moving toward a public offering.
Restructuring: Shifts in corporate strategy or equity structure.
Operational and Market Shifts
Strategic Partnerships or Contracts: Securing major deals that enhance market position.
Market Conditions: Substantial changes in your industry or competitive landscape.
Regulatory Developments: Changes that affect your business operations.
When to Opt for a Professional 409A Valuation?
While calculating a valuation yourself is more cost-effective for early stage companies, a professional 409A valuation offers two key benefits:
IRS Safe Harbor Protection: For 12 months from the date of your 409a, you are somewhat protected from penalties related to IRS scrutiny.
Neutrality: Ensures third-party objectivity on price when offering equity to employees.
You can get your 409a directly through the Equidam platform, by logging into your valuation profile and visiting the ‘ESOP & 409a’ tab on the left-hand menu.
Conclusion
For many startups, a 409A valuation is not just a legal requirement but also a strategic tool for offering equity, maintaining compliance, and building credibility with employees and investors.
If you’re unsure, follow the checklist, assess your company’s specific needs, speak to an advisor, and feel free to get in touch with us directly.