Get your company valued today if you haven't already - it's important for a variety of reasons! Knowing how much your business is worth and when a 409A valuation is required helps you make decisions about marketing and expansion, and it's also a good idea to get it done every year so you can track progress and growth.
What is a 409A valuation?
An independent evaluation of the common stock's fair market value (FMV) is known as a 409A valuation. The price to buy a share is determined by this appraisal from Internal Revenue Code (IRC) Section 409A. The 409A valuation helps to ensure that the shares are priced correctly and employees are not overcharged for their equity.
You can't offer equity without knowing how much it's worth. That's where a 409A valuation comes in. If you're looking to offer equity, you'll need to have one of these done.
To arrive at the valuation, several factors of the firm are examined, including management, potential earnings projections, capital structure, and the market worth of its assets. The technique or mix of approaches employed is determined by the industry, business, and evaluator. However, some of the most prevalent ones are market, income, and asset-based valuation methodologies.
When is the right time to get a 409A
You should know when a 409A Valuation is required. The right time to get a 409A valuation for your startup depends on certain events, such as raising funds or hiring employees who will be paid with equity. If you get a 409A value too soon, you will be wasting valuable early-stage funds on a service that will most certainly cause unneeded difficulty. Get a 409A too late, and you risk selling underpriced options which can net you serious fines from the IRS. To make sure you're making the best decision for your company, consult with an expert who can help you understand the ins and outs of the 409A process and make sure you're getting it done at the right time for your business.
How do you know you need a 409a valuation?
A 409A valuation, which is essentially a study that examines the value of your company's stock options, is required on a few occasions. You'll need one of these:
- Once every 12 months
- Following a substantial event
- Following a round of venture funding
- In the event of an imminent IPO, merger, or acquisition
If you offer equity in your company, you need to obtain a 409A valuation before issuing any common stock options. Early-stage companies and founders also need 409A valuations to keep shareholders from being subject to tax penalties that could be assessed by the IRS; a reputable 409A valuation service can assist you in utilizing "safe harbors."
- 1. Obtaining a 409a when beginning to plan stock options: A new company, even with great co-founders and ideas, may have trouble attracting talent because of a lack of spare cash to pay employees. Offering stock options is a way to bring in employees to a startup and give them an incentive to help the company succeed in the long term. However, if a company sets up a new employee with a stock option plan and the strike price is lower than what the IRS later deems acceptable, the company could get penalized. At best, they would have to pay a 20% penalty on their valuation. That's in addition to any taxes owed on the difference between the strike price they paid and what has later been deemed an appropriate fair market value. It's beneficial for both a company and its employees to get a 409a valuation done when the former starts to compensate them with stock options as part of their pay. In the long term, this will help the firm to save money.
- 2. Receiving a 409a after a substantial event at your organization: A "material event" is anything that changes the value of your company. 409a Valuations are a material event and include:
- Variations in the value of both cash and its equivalents
- Variations in equity's FMV
- Changes in the amount of common stock shares that are still outstanding
- Joining forces with another business
- Acquiring another enterprise
- Acquiring by another enterprise
- Selling of common stock
- Significant modifications to your company model or financial predictions
Anytime there is a material event, you should get a 409a, but it is especially important to get one after a qualified financing round. Once your company has been funded by investors, its value has changed.
When Is 409A Valuation Required?
The right time to get a 409a valuation for your startup depends on events such as fundraising or hiring employees paid with equity. If you get a 409a valuation too early, you may expend early-stage capital on a service that will likely create unnecessary inconvenience. If you get a 409a valuation too late, you may risk selling underpriced options, which can net you serious fines from the IRS.
IRC 409A valuations are valid for a maximum of 12 months after the effective date, or until a material event occurs. A material event potentially has an impact on the stock price of a corporation.
"Qualified finance" is the most often encountered material event for startups. This typically includes a sale of common shares, preferred equity, or convertible debt to independent investors who are not employed by the company, at a negotiated price.
If your valuation isn't done using one of the IRS-approved techniques, you may violate the 409A safe harbor. The IRS is unlikely to audit most companies. However, as your firm expands and prepares for an exit, you may face IRS examinations. Working with a reputable valuation firm from the outset can save you time and money. To obtain a precise value from a 409A valuation calculator, you must contact a third-party consultant. That's where we come in. We have a staff of seasoned, NACVA-certified individuals that can produce audit-defensible 409A valuations. You'll be able to assess where you are and determine how far you want to go with your company if you grasp what it's worth with the aid of a business valuation calculator.