409A Valuation

An independent appraisal of a private company's fair market value, used to set the strike price for stock options.

A 409A valuation is an independent third-party appraisal of a private company's common stock fair market value. The name comes from Section 409A of the Internal Revenue Code, which governs deferred compensation and requires that stock options be granted at no less than fair market value. Companies must obtain a 409A valuation before granting options — setting a strike price below fair market value triggers immediate taxation and penalties.

For employees, the 409A valuation matters because it determines the strike price of any stock options you're granted. A low 409A (common at early-stage startups) means a low strike price, which means more potential upside. As a company raises funding at higher valuations, the 409A typically rises — making later-stage option grants less attractive relative to earlier ones.

409A vs. Preferred Share Price

Investors typically buy preferred stock with rights that common stock doesn't have — liquidation preferences, anti-dilution protections, and priority in a sale. Because common stock (what employees get) is less valuable than preferred, the 409A valuation of common shares is typically set at a discount to the latest preferred round price — often 25–40% lower at early stages. As the company matures and approaches an IPO, this discount narrows.

Why It Matters for Employees

  • Your strike price is set by the 409A — the lower it is relative to the future exit price, the more your options are worth.
  • Exercising options below their 409A valuation triggers taxes and IRS penalties — the 409A protects you from this if set correctly.
  • A 409A conducted right after a funding round may be stale — ask when it was last updated.
  • If you're joining a company between funding rounds, the 409A may not reflect the most recent investor interest.

When 409As Are Updated

Companies are required to update their 409A valuation at least once every 12 months, or sooner after a material event — a new funding round, an acquisition offer, or a significant change in business outlook. If you receive options shortly after a funding round, the 409A may still reflect the pre-round value. Companies are supposed to update promptly, but there's a window where the stated FMV and the company's actual trajectory may diverge.

Example

A startup raises a Series A at a $40M valuation. An independent firm conducts a 409A valuation and sets common stock fair market value at $0.80/share (lower than preferred due to liquidation preferences). Employees receive options with a $0.80 strike price.