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  • Chas Rampenthal

What is a 409a valuation?

Understanding a 409A Valuation

A 409A valuation is a crucial financial document that every startup company will eventually need. It is a formal assessment of the fair market value of a company’s common stock, and it is used to determine the appropriate strike price for stock options offered to employees. The purpose of a 409A valuation is to ensure that the exercise price of an employee’s stock options is equal to the fair market value of the stock at the time the options were granted. Failure to issue stock at the fair market value, backed by a 409A independent valuation report, could have adverse tax consequences for both the employee and the company.

A 409A valuation is most useful when performed by an independent, qualified third-party evaluator. The evaluator will use several methods, including a discounted cash flow analysis, to determine the value of the company’s common stock. This valuation will then be used as the basis for setting the strike price for employee stock options. Doing so will offer a “safe harbor” for the company and shift the burden of challenging a valuation from the company to the IRS.

It is important to note that Section 409A is a requirement of the Internal Revenue code, and therefore applies to stock issuances from companies in the US or to workers subject to IRS regulations.

Why is a 409A Valuation Important?

A 409A valuation is an important document for several reasons:

  1. Compliance with IRS regulations: A 409A valuation is required by the Internal Revenue Service (IRS) for all companies that offer stock options to employees. The IRS uses the 409A valuation to ensure that companies are following the correct tax laws and regulations.

  2. Protection of Employee Stock Options: The 409A valuation helps to protect the value of employee stock options by ensuring that the strike price is set at a fair market value. This helps to prevent the company from granting options at a price that is less than their value when granted, which creates adverse tax consequences for the employee and company.

  3. Attraction and Retention of Top Talent: Companies that offer stock options to employees can use a 409A valuation to demonstrate their commitment to attracting and retaining top talent. A fair and accurate valuation can help to increase employee confidence in the company and its future success.

  4. Investors: Investors want to see that a company has a solid valuation process in place, and a 409A valuation can provide them with assurance that the company’s stock options are being granted at a fair market value.

Companies that offer stock options to employees should not overlook the importance of a 409a valuation. This is why Dinari lets you request your company’s 409a valuation directly from the platform! Moreover, you can also request a separate valuation for your company’s shares in a different country, since not all countries accept nor honor a 409a valuation. These separate valuations done through the Dinari platform will ensure that your company is compliant when issuing equity to foreign employees. In turn, ensuring compliance with IRS regulations and foreign rules and regulations will protect the value of your employees’ stock options so that you can attract and retain the best talent, all while providing assurance to your investors.

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