1. What Is a 409A Valuation?

Is your startup planning to offer stock options to employees? Then getting a 409A valuation is essential.

Never heard of a 409A valuation? No problem.

Here are seven things you need to know about a 409A valuation.

Essentially, a 409A valuation is an appraisal of the fair market value of your startup company’s common stock.

With publicly traded stock it’s easy to see the specific prices for any given time of day. But for private company stock, you need an independent valuation to see how much your company stock is worth.

Stock options are considered deferred compensation. A 409A valuation will determine a “strike price” (the price at which your employees can buy equity in your company) that must be at or above fair market value.

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.

If you plan to offer common stock options, then there are two times you must get a 409A valuation.

Essentially, a 409A is an appraisal. To determine this, firms will generally take one of the following approaches to appraise fair market value:

You have three options to get a 409A valuation report:

It can be really bad if you don’t price your stock options because the IRS sees that as giving away something valuable. This can cause major tax issues.

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. But if your startup becomes successful and starts making money, an IRS audit becomes a greater possibility. This will be expensive and time consuming.

In addition, you’ll likely face serious questions from the Securities and Exchange Commission, which looks closely at pre-IPO stock awards.

So protect your company and your employees. Get a 409A valuation.

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