409A Valuation Explained for Founders and Employees

A 409A valuation is an independent appraisal of the fair market value of a private US company's common stock. Startups need one to set the exercise price (strike price) of the stock options they grant employees. It's usually much lower than the price investors paid in the latest funding round, and getting it wrong can create serious tax problems for employees. This guide explains what founders and employees need to know.

Why it's called "409A"

The name comes from Section 409A of the US Internal Revenue Code, introduced in 2004, which governs deferred compensation. Stock options granted with an exercise price below the fair market value of the shares on the grant date can be treated as deferred compensation that fails 409A rules. If that happens, employees can face immediate income tax on the discount, an additional 20% penalty tax and interest. To avoid this, companies must grant options at or above fair market value, and a 409A valuation is how they establish that value.

409A value versus funding round valuation

When a startup announces it raised money at a US$100 million valuation, that figure comes from the price investors paid for preferred shares. Preferred shares come with rights that make them more valuable than common shares: liquidation preferences, which pay investors back first in an exit, anti-dilution protection, and sometimes board seats and veto rights. Common shares, held by founders and employees, have none of these.

A 409A valuation reflects those differences and the lack of a market for common shares. As a result, the 409A price per common share is often a fraction of the preferred price, frequently 20% to 50% of it for early-stage companies, rising closer to the preferred price as a company approaches an IPO. That gap is why employees can receive options at a low strike price even after a high-profile funding round.

How a 409A valuation is done

Independent valuation firms typically use a combination of methods:

• Market approach: using the price of the latest funding round (the "backsolve" method) or comparisons with similar public companies and acquisitions. Our guide to building a comparable companies list explains comparables.
• Income approach: estimating future cash flows and discounting them, more common for later-stage or profitable companies.
• Asset approach: valuing the company's assets, used mainly for very early companies with little revenue.

The firm then allocates the company's total equity value across share classes, accounting for preferences, often using an option pricing model or a probability-weighted scenario analysis. Finally, it applies a discount for lack of marketability (DLOM), because common shares in a private company can't easily be sold.

Safe harbor

If a company obtains its 409A valuation from a qualified independent appraiser, the IRS generally presumes the valuation is reasonable unless it can show otherwise. This "safe harbor" shifts the burden of proof and is the main reason startups use independent valuation firms rather than setting prices themselves.

When to get one

• Before granting the first stock options.
• At least every 12 months.
• After a material event, such as a new funding round, a significant change in revenue or business, an acquisition offer, or a large secondary sale.

Granting options using an out-of-date 409A after a funding round is a common and avoidable mistake.

Cost

For early-stage startups, a 409A valuation typically costs from a few hundred to a few thousand US dollars, and some cap table platforms bundle it with their software. For later-stage companies with complex capital structures, costs can run to tens of thousands of dollars. It's a small price compared with the potential tax consequences of getting it wrong.

What employees should know

• Your strike price is usually the 409A fair market value on your grant date.
• A low 409A is good for new hires, because it means a lower exercise price and more potential upside.
• The headline valuation isn't your share value. Your options' value depends on the common share price, not the preferred price in press releases.
• Tax depends on option type. In the US, incentive stock options (ISOs) and non-qualified options (NSOs) are taxed differently; exercising ISOs can trigger alternative minimum tax based on the spread between strike price and current 409A.
• Tender offers may be at different prices. When companies run tender offers, the price can be close to the preferred price, which affects taxes on the sale.

Our guide to employee option pools explains how option grants fit into a company's capital structure, and our guide to reading a cap table shows how share classes appear.

409A and secondary sales

When employees sell common shares in tender offers or secondary sales at prices well above the 409A value, valuation firms must consider whether those transactions reflect fair market value. Large secondary transactions at high prices can push the next 409A valuation up, which raises strike prices for future hires. Some companies structure tender offers carefully to limit this effect. Interestingly, some companies have used a 409A valuation to price an employee buyback; Checkout.com's 2025 share buyback was based on an internal 409A valuation.

Common mistakes

1. Granting options before obtaining a 409A.
2. Using a 409A that is more than 12 months old or predates a funding round.
3. Assuming the funding round price is the fair market value of common stock.
4. Not updating the 409A after major events, such as a big revenue jump or acquisition offer.
5. Employees exercising ISOs without understanding the alternative minimum tax.

Outside the US

Other countries handle employee equity differently. In the UK, Enterprise Management Incentive (EMI) options use valuations agreed with HM Revenue & Customs. Canada taxes stock option benefits under its own rules, with specific treatment for Canadian-controlled private corporations. If you're a founder outside the US or hiring US employees from abroad, take local advice; many international startups need a 409A specifically because they grant options to US-based staff.

A worked example

Suppose a startup raises a Series A by selling preferred shares at US$2.00 each, valuing the company at US$40 million post-money. The investors' preferred shares carry a 1x non-participating liquidation preference. A valuation firm estimates the company's total equity value, then models possible outcomes: an acquisition at a low price, where preferred shareholders take most of the proceeds; a moderate exit; and a large exit or IPO, where all shares convert to common and are worth the same. Weighting those outcomes and applying a discount for the lack of a market for common shares, it might conclude that common stock is worth about US$0.60 per share. Options granted after that valuation would carry a US$0.60 strike price, even though investors paid US$2.00.

As the company grows and approaches an exit, the probability of large outcomes rises, preferences matter less, and the marketability discount shrinks. By the time of an IPO, the 409A value usually converges close to the preferred price.

409A for companies raising on SAFEs

Many early startups raise money using SAFEs or convertible notes rather than priced rounds. These instruments don't set a share price immediately, but they can still affect a 409A valuation, because the valuation cap and terms indicate how investors value the company. Valuation firms take outstanding SAFEs into account when estimating common stock value. Founders should still obtain a 409A before granting options, even if they haven't raised a priced round.

Choosing a valuation provider

Founders can choose from specialist valuation firms, accounting firms and cap table software platforms that offer bundled 409A services. Things to consider include the provider's experience with companies at your stage and in your sector, turnaround time, cost, and whether the report will stand up to auditor review as the company grows. Later-stage companies, especially those preparing for an IPO, usually move to more established valuation firms because auditors and regulators scrutinise valuations more closely.

409A and financial reporting

The fair market value of common stock also feeds into accounting for stock-based compensation, the expense companies record for employee equity under US accounting rules (ASC 718). Higher 409A values mean higher recorded compensation expense, which affects reported losses. That's one reason company finance teams pay close attention to 409A results, and why stock-based compensation can create large accounting expenses even though no cash is spent.