What is a 409A valuation? Definition, how it works and examples
The appraisal behind every option grant in a private company — what it values, why it sits below the price of the last round, and when it has to be redone.
The short answer
A 409A valuation is an independent appraisal of the fair market value of a private company’s common stock, done so the company can grant employee stock options at a strike price the IRS will accept — at or above that value on the grant date — and keep the options outside the penalty regime of Section 409A. It is not the price investors paid. A 409A values common stock, which sits behind preferred stock in an exit and cannot be sold freely, so it usually comes in well below the price of the last round.
What is a 409A valuation used for?
Section 409A of the Internal Revenue Code taxes deferred compensation that does not follow its rules. A stock option is outside 409A only if its strike price can never be less than the fair market value of the stock on the day it is granted. For a listed company that value is a market price. A private company has none, so it needs an appraisal — the 409A valuation, also called a 409A appraisal or a section 409A valuation. The appraisal sets the 409A price: the per-share value of common stock that the board uses as the floor for option strikes until the next appraisal.
Why common stock is appraised below the last round’s price
Investors in a priced round buy preferred stock. Preferred carries a liquidation preference — in a sale it is repaid before common receives anything — and often other rights common does not have. So the headline price per preferred share overstates what one common share is worth by construction. The cap table shows how much preference sits ahead of common. The appraiser first estimates the value of the whole company’s equity — often by working back from the last round’s price — then allocates it across the share classes using a model that pays out the preferences first.
What is a section 409A valuation required to show?
The regulation requires “the reasonable application of a reasonable valuation method”. It lists the factors: the company’s tangible and intangible assets, the present value of its future cash flows, the value of comparable companies, recent arm’s-length transactions in its stock, and control premiums or marketability discounts. A method that ignores material information is not reasonable, and neither is a value that is more than 12 months old or predates a material event. Three methods are presumed reasonable.
409A valuation example: from a $40 round to a $13.50 strike
A company closes a Series C at $40.00 per preferred share. Two months later it commissions a 409A for its common stock. The steps below follow what goes into a 409A valuation report, with simplified numbers. An employee granted 10,000 options at $13.50 pays $135,000 to exercise. If the company later lists at $40.00, the spread is $265,000. Had the board set the strike at $10.00 — below the appraised value — the options would be discounted, would fall inside 409A, and the spread would be taxed with the 20% additional tax as it vested.
Common mistakes with 409A valuations
Granting on a stale report A report older than 12 months, or one that predates a new round, gives no presumption. Grants made on it carry the risk. Treating the 409A as the company’s value It prices common stock for tax. It is not the round price and not what a secondary buyer will pay. Using the start-up method too late Within 180 days of an expected IPO, or 90 days of an expected sale, the illiquid start-up presumption is gone. Ignoring secondaries and tenders Trades in the company’s own stock are evidence the appraiser has to weigh. Leaving them out makes the method unreasonable.
The terms this page uses
Fair market value For 409A, the value of a share on a date determined by a reasonable method — the floor for an option’s strike price. Common stock The class founders and employees hold, paid after preferred in an exit. A 409A values this class. Preferred stock The class investors buy in a priced round, with a liquidation preference and other rights common lacks. Liquidation preference The amount preferred holders receive in a sale before common receives anything, usually their investment back.
What people ask about 409A valuations
What is the 409A valuation meaning in plain terms? It is the appraised value of one common share of a private company on a date. The board uses it as the minimum strike price for employee options, so the options are not taxed as deferred compensation. How often does a startup need a 409A valuation? At least every 12 months while it grants options, and again after any material event such as a new priced round. A value older than 12 months, or one that predates a material event, is not reasonable under the regulation. Why is my 409A price lower than what investors paid?
What is the 409A valuation meaning in plain terms?
It is the appraised value of one common share of a private company on a date. The board uses it as the minimum strike price for employee options, so the options are not taxed as deferred compensation.
How often does a startup need a 409A valuation?
At least every 12 months while it grants options, and again after any material event such as a new priced round. A value older than 12 months, or one that predates a material event, is not reasonable under the regulation.
Why is my 409A price lower than what investors paid?
Investors bought preferred stock, which is paid first in an exit and carries other rights. The 409A values common stock after those preferences and after a discount for lack of marketability.
What is needed for a 409A valuation?
Typically the cap table and share-class terms, financial statements and forecasts, the terms of recent rounds and any secondary sales or tender offers, and details of material events. The appraiser weighs these against the factors the regulation lists.
Is a 409A valuation the same as the price of shares on a secondary market?
No. A secondary trade prices a specific block between a willing buyer and seller, often of preferred stock. A 409A is a tax appraisal of common stock, and secondary trades are only one input to it.
Where every rule on this page comes from
Every rule was checked against the statute and the Treasury regulation; the last verification was 1 October 2026. The worked example is illustrative. A 409A is a US federal tax concept; other jurisdictions price employee equity under their own rules.