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409A valuations for startups and scale-ups

Employee share schemes benefit your startup by tying an employee’s financial reward to business performance and ensuring employees feel invested in the company’s success. As the war for talent heats up, employee equity is becoming an increasingly powerful means of attracting and retaining the employees your business needs to grow.

Before we get started, here are some of the key terms related to 409A valuations:


  • Internal Revenue Service (IRS)
    Internal Revenue Service, commonly abbreviated to IRS. The US federal government department is responsible for collecting taxes and administering the Internal Revenue Code (IRC), the main body of the federal statutory tax law.

  • Incentive Stock Option (ISO)
    An incentive stock option, commonly abbreviated to ISO, is a type of stock option that can be granted to employees (only) and qualifies under the Internal Revenue Code (IRC) to receive tax-favourable treatment.

  • Non-qualified Stock Option (NSO) 
    A non-qualified stock option, commonly abbreviated to NSO, is a form of equity compensation that can be provided to employees and other stakeholders.

  • Material event
    an event that triggers a change in the share value of the business such as a new qualified financing round of equity or debt financing, a significant sale of common shares or an M&A transaction.

If you're UK-based and looking for information on HMRC valuations for EMI and CSOP share schemes, check out HMRC valuations for startups and scale-ups.


What is a 409A valuation?

In the US, 409A valuations set the price of purchasing a share in your business. This price is known as a share’s Fair Market Value (FMV) – the theoretical value of a share if it could be sold on the open market.

409A valuations are used by private businesses to establish the value of equity and to ensure they are granting options at the right price. They are comparable to EMI or CSOP valuations and play a similar role in employee equity schemes. However, there are significant differences between these financial mechanisms.

 

What does 409A refer to?

409A refers to the section within the IRS’s Internal Revenue Code (IRC) that covers valuations for businesses awarding employee equity. It contains a framework that companies must follow when performing a valuation.

 

When do you need a 409A valuation?

Your business needs a 409A valuation when you issue options for the first time*, you complete a venture financing round, you’re preparing for an IPO, merger or acquisition, and whenever a material event occurs.

Each 409A valuation is valid for 12 months. Once the 12-month period is over, the valuation expires and you need to complete a new 409A valuation in order to remain audit-proof.

 

Why do you need a 409A valuation?

If you’re producing company valuations internally, they are taking valuable time away from your finance team. And, if you’re based in the US, you have liability for burden of proof.

Unlike HMRC valuations, which work on an approval basis – where you’re provided with pre-clearance to grant equity under your chosen EMI or CSOP scheme – 409A valuations are performed in the event of an audit.

Once you have the 409A valuation report, you can begin using your valuation in employee equity issuances.

In the event of an audit by the IRS, you may need to defend your 409A valuation or answer questions about it. In the US, you’re insured against liability due to safe harbor.

 

How do I prepare for a 409A valuation?

Typically, you’ll need to supply the following information as the basis for compiling a 409A valuation report:

  • Qualitative information
    Acompany overview, any updates since your last valuation, management bios and any significant company events (fundraising, IPO, M&A or secondaries)

  • Financial information
    Your historical financial records, forecasted revenue, amount of non-convertible debt, and cash burn and runway information. Details of any material events since your last valuation are also important.

  • Structural information
    Your capitalization table by share class, option ledge and articles of incorporation.

Need a 409A valuation? Get fast, accurate valuations from Capdesk. 

What should I pay for a 409A valuation?

If you shop around, you’re likely to find a 409A valuation service in the US that will set you back anywhere from £1000 to £5,000 for a single valuation.

However, using a provider that already has your cap table data is beneficial, it speeds up the process, reducing the time to deliver a valuation report and can be an effective way to manage repeat valuations in the future.

 

How long does a 409A valuation take?

Commonly, it takes two weeks to get a final draft of your 409A valuation going through numerous stages of data collection, calls and drafts to arrive at the final report.

However, opting for a provider that securely stores your cap table, option ledger and other company data, like Capdesk, your 409A valuation is delivered in three to five business days.

You may also need to obtain approval from the Board and then you can begin granting options once you have the approved final valuation report.

We simplify the valuations process and do all the heavy lifting. In turn, you can grant equity more regularly, enabling you to enrol new employees in your equity scheme on a rolling basis. By acquainting your employees with the benefits of share schemes as quickly as possible, you start rewarding new team members as soon as they start working for your business.


Capdesk now offers valuation services with the unbeatable expertise of industry leaders Carta behind us. Carta is the leading provider of 409A valuations in the US – its valuations team performs 15,000 valuations per year.

 

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