409A Valuation

TL;DR

An IRS-required independent valuation of a private company's common stock, used to set the strike price for new option grants.

Named after Section 409A of the US tax code, a 409A valuation establishes the fair market value of common stock so option grants can be priced compliantly. Failing to perform a 409A or pricing options below fair market value triggers severe tax penalties for option recipients.

409A valuations are typically refreshed annually or after material events (financing, M&A, significant operational change). The 409A FMV is almost always lower than the preferred-share price from the most recent priced round — usually a discount of 30–80% depending on stage and company maturity.

Worked example

After a $50M post-money Series B, the 409A appraiser sets common stock at $1.10/share (vs preferred at $4.50/share — a typical ~25% common discount). New employee options issued at $1.10 strike; if FMV doubles in 18 months, exercising creates a 1.0×-spread tax event.

Common pitfalls

• Skipping 409A and triggering severe employee tax penalties.
• Letting 409A go stale and granting options at outdated strike prices.
• Confusing 409A FMV with the preferred-share price from the last round.

When this shows up in a pitch deck

Operational hygiene; appears in due diligence as part of clean cap-table review.

Related terms

• Strike Price — The fixed price at which an option holder can purchase a share, set at fair market value on the grant date and locked in for the option's life.
• ISO — A US tax-advantaged stock option for W-2 employees, eligible for long-term capital-gains treatment if holding-period requirements are met.
• NSO — Non-Qualified Stock Options — a more flexible US option type than ISOs, available to contractors and advisors but without the same tax-advantaged treatment.
• Common Stock — The base equity class held by founders and employees, with voting rights but no preference rights or dividends.
• Preferred Stock — The equity class issued to investors, carrying special rights such as liquidation preference, anti-dilution protection, and protective covenants.

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