Stock options must be granted with a strike price at least equal to the fair market value of the common stock on the grant date. Grant below fair market value and the option can fall under Section 409A's deferred compensation rules, with additional tax and penalties for the employee. A 409A valuation is how private companies establish that value with a presumption of reasonableness.
The safe harbor
Treasury regulations give a presumption of reasonableness to a valuation performed by a qualified independent appraiser, among other methods. The IRS can rebut the presumption only by showing the valuation was grossly unreasonable. For most venture-backed companies, an independent appraisal is the practical choice.
How long it lasts
A valuation generally may not be relied on if it is more than 12 months old at the grant date, or if information available after the valuation date materially affects value. Common refresh triggers:
- A priced equity round
- Significant SAFE or convertible note financings
- A large change in revenue or forecast
- A secondary sale or tender offer
- An acquisition offer or major strategic change
What the appraiser needs from finance
| Item | Notes |
|---|---|
| Recent financial statements | Monthly, GAAP basis, year to date and prior year |
| Forecast | Revenue and expense projections with assumptions |
| Cap table | Fully diluted, with preferred terms, SAFEs and notes |
| Financing documents | Latest round terms, liquidation preferences |
| ARR and metrics | Growth, retention, gross margin |
| Cash and debt | Balances and terms |
Clean financials shorten the engagement and make the conclusion easier to defend.
What the appraiser does with it
Appraisers usually value the whole company first, often by weighting market comparables, recent financing prices and a discounted cash flow, and then allocate that value across preferred and common stock using a method that reflects the preferred stock's liquidation preferences. A discount for lack of marketability is commonly applied to the common stock. The quality of your forecast and the clarity of your financing terms directly affect how defensible each step is.
Common mistakes
- Granting options months after the valuation date without checking for material events in between.
- Letting the valuation lapse past twelve months while hiring continues.
- Using a forecast in the 409A that differs from the one shown to investors without being able to explain why.
Board process
Have the board approve option grants at a price supported by a current valuation, with the valuation report referenced in the minutes. Grants made between a material event and a refreshed valuation are a common diligence finding.
How we help
We prepare the financial package for the appraiser, keep the cap table reconciled to the equity platform, track valuation dates against grant dates, and flag when an event calls for a refresh.
Timing grants around financings
The cleanest practice is to refresh the valuation promptly after a priced round closes and hold new grants until the report is final. Granting in the weeks between a signed term sheet and a refreshed valuation is a common diligence question, so coordinate grant timing with the board calendar.
Sources
Questions founders ask
How long is a 409A valuation good for?
A valuation used under the safe harbor generally cannot be more than 12 months old at the grant date, and it must be refreshed sooner if a material event changes the company's value.
Does a SAFE trigger a new 409A?
A financing can be a material event. Many companies refresh the 409A after any priced round and evaluate after significant SAFE rounds.
