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Do you want a high or low 409A valuation?
Definition A 409A valuation is an assessment private companies are required by the IRS to conduct regarding the value of any equity the company issues or offers to employees. A company wants the 409A to be low, so that employees make more off options, but not so low the IRS won’t consider it reasonable.
Why is 409A valuation important?
409A valuations determine the fair market value of common stock. To take advantage of the IRS safe harbor (i.e. not be subject to certain IRS penalties), 409A valuations should be done annually or each time the company has a material event, like a new financing.
What is a 409A valuation for a private company?
For a privately-held company, the 409A valuation is the only method you can use to grant options on a tax-free basis to your employees. (For more on how startup options work and key terms involved, please see this post .)
What are 409A options and why should VCS care?
The IRS’s 409A rules also prevent the use of absurdly low option prices. Those laws are designed to prevent the disguising of income in the form of unexercised options that are already in the money. As such, VCs shouldn’t have to spend any effort pushing for this balanced outcome.
Can a 409A be used to delay the payment of tax?
But if the company got the 409A valuation done on time, and used the real value of the shares at that time ($5 per share), the employee would be able to delay the payment of the tax until they exercise the option and purchases the stock. The delay could be many years after the audit is performed by the IRS.
Is 409A a good or bad thing?
In the short-term, YES, it is a good thing. Low 409A == low strike price on newly issued options. If it’s low enough, it enables early-exercise of options, which then become real shares (shareholders rights + capital gains tax treatment). In the long-term, it’s a BAD thing.