How much is a stake in your business worth? Once you’ve gone public, that figure is determined by the market. Private companies, however, are evaluated by other means.
A 409A valuation is an independent assessment of the fair market value of your company’s ordinary shares. The valuation, named after section 409A of the IRS Internal Revenue Code (IRC), also sets the price of a share.
If you’re issuing equity to your employees – even a single share option – you need to determine its value. That’s where a 409A valuation comes in.
In this article, we’ll explain the fundamentals of 409A valuations, and help you assess potential providers. For a thorough breakdown of 409A valuations, read through from start to finish. If you know what you’re looking for, jump ahead to a particular section.
If you offer equity to employees or advisors who are US citizens, then you need a 409A valuation. Your 409A valuation should be in place before you issue your first option grants. Even if the US citizens you employ reside outside of the US, you still need a 409A valuation to be compliant with the IRS.
You should get a 409A valuation:
A 409A valuation is valid for 12 months, or until a material event takes place.
What’s a material event? Anything that affects a company’s value, and therefore its share price.
The most likely material event you’ll go through is “qualified financing”, where your company sells shares or convertible debt to investors.
Other kinds of material event include:
If you’re unsure whether you’ve been through a material event, consult a 409A valuation provider – you can book a call with us today – or consult your lawyer.
IRC Section 409A was introduced in the wake of the 2001 Enron scandal, during which the energy company manipulated its share price to maximise profits. Regulators responded by implementing measures that stop executives from exploiting equity loopholes. IRC Section 409A was eventually launched in 2005.
Section 409A dictates how private companies must perform their valuations. It also sets out “safe harbor”, meaning that valuations performed by an independent provider – such as Capdesk – are presumed to be reasonable by the IRS.
If you don’t follow 409A guidance, and issue share options that are priced incorrectly as a result, you could be penalised by the IRS. Unfortunately, it’s often your employee stakeholders that bear the brunt of this.
The cost of a 409A valuation varies greatly, dependent on the provider and the service agreement. You can purchase a one-off valuation from some providers, such as an accounting firm, for anywhere between £1,000 and £5,000 – depending on the size and complexity of your company.
At Capdesk, 409A valuations are included in the price of our Scale package. The service includes an annual valuation, plus one additional material event-related valuation each year.
If your 409A is performed in a particular way, it’s given “safe harbor” status. Safe harbor means the IRS presumes your valuation is valid unless they can demonstrate that it’s “grossly unreasonable”.
There are three safe harbor valuation methods, the most common method being independent appraisal presumption. Independent appraisal presumption requires your appraisal to be done by a qualified, third-party provider.
If the 409A valuation is performed within 12 months of the option grant date, and no material events have taken place since then, it’s presumed reasonable. If the valuation is challenged by the IRS, the burden of proof is on them.
A range of financial information is used to determine your company valuation, whether you’re performing it in-house or through a provider such as Capdesk. You will need to provide the following data and company insights:
If your company valuation doesn’t meet IRS standards, you could be penalised. For your employees and shareholders, this could mean:
Through Carta, Capdesk now offers audit-proof 409A valuations. Carta performs 15,000 valuations every year, leveraging proprietary software and industry expertise to perform valuations faster and more efficiently than other providers.
Find out more about Capdesk 409A valuations today:
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