Does my company need a 409A valuation?

Does my company need a 409A valuation?

Generally, you should get your first valuation before you issue your first common stock options (typically to your first hire or advisor). You will also need a new valuation after raising a round of venture financing, as the previous 409A becomes obsolete once the new round is raised.

Who is subject to 409A?

Section 409A applies to anyone subject to U.S. federal income taxation who receives nonqualified deferred compensation, including (1) U.S. tax residents and (2) nonresidents of the United States who earn U.S.-source compensation.

What is a 409A plan?

A 409A plan sets a “strike price,” which is the price that employees can buy equity in the company. This nonqualified deferred compensation is different from deferred compensation that comes from qualified plans like 401(k) plans, 403(b) plans, and 457(b) plans.

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What is 409 cap a?

Section 409A of the United States Internal Revenue Code regulates nonqualified deferred compensation paid by a “service recipient” to a “service provider” by generally imposing a 20\% excise tax when certain design or operational rules contained in the section are violated.

Who can perform 409A valuation?

While there are many ways financial experts (e.g. M&A experts, equity research analysts, VC firms) can determine enterprise value, in 409A valuation work, there are three main methodologies: market, income, and asset-based.

What is a Section 409A valuation?

A 409A is an independent appraisal of the fair market value (FMV) of a private company’s common stock, or the stock reserved for founders and employees. This valuation determines the cost to purchase a share. Long story short: You can’t offer equity without knowing how much a share is worth.

Do I need a 409A valuation?

Simply, a 409A valuation is required by law. You need a 409A valuation to ensure your company is in compliance. Non-compliance can have terrible consequences. Undervaluing stock options can result in major IRS penalties and lost compensation.

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What is 409A and how does it affect stock options?

409A is a framework that privately held companies can use when granting private stock options. Under 409A, equity-based awards need to be issued at or above FMV at grant date. That valuation sets the tax basis for non-qualified stock options. Over time, if the company does well, those shares will gain value.

What are the penalties for a 409A audit?

Any option holders discovered to be in violation of 409A will have to pay taxes plus a 20 percent federal penalty, any applicable state penalties, an IRS tax underpayment penalty, and any interest on unpaid taxes. Most startups likely won’t face a 409A audit from the IRS.

Why should startups comply with IRC 409A?

Complying with IRC 409A also ensures that new startups get off on the right foot, both in terms of complying with federal and state law (where applicable) and laying the groundwork to incentivize or reward employees and attract new hires using deferred compensation.

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