Fundraising & Rounds
What is a 409A valuation?
A 409A valuation is an independent appraisal of a startup's fair market value for common stock, required by the IRS to set legal strike prices for employee stock options.
A 409A valuation (named after Section 409A of the Internal Revenue Code) is an independent third-party appraisal of a private company's fair market value for its common stock.
Why it matters: When a startup grants stock options to employees, the IRS requires that the strike price (exercise price) be set at or above the fair market value of common stock at the time of grant. Granting options at below-FMV prices creates immediate taxable income for employees — a nasty surprise.
Why common stock is worth less than preferred: VC-held preferred stock has liquidation preferences and other rights that common stock doesn't have. So the 409A valuation (which sets the value of common stock) is almost always lower than the company's last round valuation (which reflects preferred stock pricing). The discount is typically 20-50% of the preferred price.
When you need one: Before granting any options. Typically refreshed every 12 months, or within 6 months of a new funding round.
Who does them: Third-party valuation firms (common providers: Carta, Carta Valuations, Andersen, 409 Valuations). Cost: $1,000-$5,000.
IRS safe harbor: Using an independent 409A valuation provides a 'safe harbor' — if the IRS audits, the burden shifts to them to prove the valuation was incorrect.
For employees: Your stock option strike price is usually much lower than the preferred stock price, which is why options can have significant value.
Related glossary terms
Related questions
What is vesting and a cliff in startup equity?
Vesting is the schedule by which you earn your equity over time. A cliff is a minimum tenure required before any equity vests — typically 1 year.
What is an option pool and why do VCs require one?
An option pool is a set of shares reserved for future employee equity grants. VCs require it to ensure there's enough equity to attract and retain talent after they invest.
What is a cap table?
A cap table (capitalization table) is a spreadsheet or document that shows who owns what percentage of a company — founders, employees, investors — accounting for all shares, options, and convertible instruments.