409A Safe Harbor: What is Safe Harbor and Why Is Safe Harbor Important

The 409A Safe Harbor

A 409A valuation is utilized for determining the FMV (Fair Market Value) of a company and is issued by a reputed valuer or third-party valuation services provider. A 409A valuation is essential for setting the strike/specified price of shares given to advisors, employees etc. In order to comply with 409A, companies must perform a valuation on their own or pay for the same. The 409A valuation proves that the options are not intentionally underpriced. And that the company is actually creating them in accordance with the fair market value of their common shares/stocks.

Choosing 409A for your company

Companies must be extremely careful when it comes to selecting a 409A valuation solution. Their decision largely depends on their risk appetite and the amount that they agree to pay for minimizing the risks.

Hence, in order to analyze the risk, companies must understand:

  • The IRS compliance standards.
  • Their auditing potential.
  • The possibility of not clearing an auditing procedure.
  • The penalties applicable for non-complying.

Safe Harbor

Companies can receive safe harbor only after they’ve completed a valuation. The company should furnish the valuation report to the IRS, and the IRS should accept such valuation. Therefore, employees become liable to pay heavy taxes in cases where a “safe harbor” test fails. Additionally, employees should also to pay additional penalties and a fine 20% of the value.

Conditions for Safe Harbor

Companies must meet the below mentioned conditions to ensure that their valuation achieves safe harbor:

  • Get their valuation made by qualified professional(s) or an appraiser.
  • Conduct it within the last twelve months.
  • Provide a report in order to prove the valuation.

When it comes to carrying out a valuation, companies can turn to:

  • qualified professionals or
  • individuals such as board members or directors with adequate investing, financial as well as valuation knowledge and expertise.

In fact, CFOs can perform the valuation with their valuation experience and knowledge, along with venture capitalists and angel investors, private equity professionals and investment bankers.

Since the definition of qualified individuals or professionals is not very clear and also because conducting a 409A valuation requires some amount of technical knowledge and expertise, the industry experts are of the opinion that experienced and trained valuation individuals or professionals are the best option for carrying out the valuation procedure.

Non compliance with 409A can be extremely painful for any start up and thus they must meet them at all costs. Depending upon their preferences, companies can opt for three different types of 409A valuations including valuations performed on its own, valuations carried out with assistance from a qualified individual and valuations done with the help of an independent appraiser or firm. Companies must determine whether there’s a scope for the IRS to challenge their valuations or not and must accordingly prepare to defend themselves.

 



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