4 Things You Need to Know About 409A Valuation

So you are a startup and you are looking to issue stock to your employees? Never heard of a 409A valuation? No problem. Here are 4 important things you need to know about 409A valuation:

1. What is 409A valuation?

In simple words, a 409A valuation is an independent valuation of your start-up’s stock, issued by a qualified valuer. If you were a listed company, valuing your business would be very easy – simply multiply the stock price from the stock exchange, by the number of shares in issue, and boom, you have the total value of your equity. But for a startup, the story is quite different.

Section 409A applies to compensation that workers earn in one year, but that is paid in a future year. This is also called as non-qualified deferred compensation.

Therefore, a 409A valuation determines the price at which your employees buy your stock. It should be equal to or above the fair value as given by an independent appraiser.

2. Why do I need a 409A valuation?

Well, the answer is pretty simple. If you are a startup, formed in the United States, and you are looking to issue stock to your employees, which fall under the definition of a “non-qualified deferred compensation”, you need a 409A valuation report. You can get this done in house, but the risks are high, and attract major IRS penalties and lost compensation.

 

3. What does it entail?

You need to get a 409A valuation once every twelve months, or every time you raise capital. A 409A valuation, usually considers three approaches, viz. the asset approach, the income approach, and the market approach to arrive at the fair value of your stock.

4. How do I get a 409A valuation done?

You have three options to get a 409A report:

  • The DIY Approach. This is the most riskiest option of the three because you do not have a “safe harbor” protection, if IRS raises questions. That essentially means that the onus is on you to prove that your valuation is correct. Though you save a few hundred dollars, the risk of not taking a professional’s help can cost you dearly.
  • The Software Approach. There are several software found on the internet, that claim to do a 409A valuation at the click of the button. This is equally risky, because ultimately you are the one giving inputs to the software!
  • Hire a Professional Firm. Getting an independent valuation is the least riskiest option, because you get a “safe harbor” protection. This implies that the IRS (not you) has the burden to prove that your valuation is wrong. Hence, you need to find a knowledgeable and experienced firm to get your 409A valuation.

 

Most startups don’t face an IRS audit for a 409A stock issue. But if you are becoming successful, and starting to make money, the chances of getting an IRS audit are high. In addition, you may also be answerable to the Securities and Exchange Commission, which looks closely at pre-IPO stock awards.

So protect your company and your employees. Get a 409A valuation.



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