409A Valuations: Why You Need One Before Hiring

You're ready to hire your first employee and want to offer equity. Great! But before you grant a single option, you need a 409A valuation. Here's why this matters and what to do about it.

What Is a 409A Valuation?

A 409A valuation is an independent appraisal of your company's common stock fair market value. It's named after Section 409A of the Internal Revenue Code, which governs deferred compensation—including stock options.

The IRS requires that stock options be granted at or above fair market value. A 409A valuation determines what that fair market value is.

Why You Can't Skip It

If you grant options at a price below fair market value, recipients face serious tax consequences:

• Immediate income tax: On the difference between strike price and FMV
• 20% penalty tax: An additional IRS penalty on the same amount
• Ongoing liability: The tax hit compounds each year the option is held

These penalties apply to the employee, not you—but good luck recruiting if you're offering toxic tax treatment.

When You Need a 409A

You need a 409A valuation:

• Before granting your first options
• Every 12 months (valuations expire)
• After any material event (financing, acquisition offer, major contract)

The valuation must be performed or confirmed within 12 months prior to the grant date to create a "safe harbor"—legal protection that the IRS will accept your valuation.

What the Process Looks Like

1. Hire a valuation firm. Carta, Aumni, and boutique valuation firms all offer 409A services. Cost: $1,000-$5,000 for early-stage companies.

2. Provide financial information. Revenue, expenses, cap table, recent financings, projections, and comparable company data.

3. Receive your report. Typically 1-2 weeks turnaround. You'll get a per-share fair market value for your common stock.

4. Use it for grants. Set your option strike price at or above the 409A value.

What Affects Your 409A Value

Several factors influence your 409A valuation:

• Preferred stock price: If you just raised at a $10M post-money valuation, your common stock is still worth less (often 60-80% less) due to liquidation preferences
• Stage and revenue: More traction = higher value
• Comparable companies: Valuations in your space
• Time since last financing: Values drift over time

Early-stage 409A values are typically much lower than headline valuations, which is actually good—it means lower strike prices for employees.

Common Mistakes

Granting before you have a 409A: Never do this. The tax liability is severe and irreversible.

Using an expired 409A: Valuations must be refreshed annually or after material events.

Setting the price yourself: The IRS requires an independent valuation. Your own estimate doesn't count.

The Bottom Line

A 409A valuation is table stakes for offering equity compensation:

• Get one before granting any options
• Refresh it every 12 months or after material events
• Use a reputable provider ($1,000-$5,000 is a worthwhile investment)
• Set strike prices at or above the 409A value

This is one of those compliance items that isn't optional. Do it right from the start.