What is a 409A Valuation?
A 409A valuation is an independent assessment of your company's common stock fair market value. Named after IRS Section 409A, it determines the minimum price at which you can grant stock options without triggering tax penalties for employees.
Why 409A Valuation Matters
If you grant options below fair market value, employees face immediate income tax on the discount plus a 20% penalty. A proper 409A provides "safe harbor" protection against these penalties.
For SaaS founders, your 409A value is typically much lower than your preferred stock price because common stock lacks the liquidation preferences and other protections investors receive. This discount benefits employees receiving options.
409A Timing and Updates
Get a 409A before issuing any options. Update it annually or after material events: raising a round, significant revenue changes, or major business developments. Stale 409As create risk.
Formula
409A providers use multiple methods:
- Income Approach: Discounted cash flow of future earnings
- Market Approach: Comparable company multiples
- Asset Approach: Net asset value
Results are weighted to determine FMV
Example
Your SaaS company raises Series A:
- Series A Price: $5.00 per preferred share
- 409A Valuation: $1.25 per common share
- Discount: 75% (typical range: 60-85%)
You can grant options with a $1.25 strike price, giving employees significant upside. If you granted at $0.50 without a 409A, employees would face tax penalties on the $0.75 "discount" from FMV.