The 409a valuation process your provider follows could be the difference between compliance and penalization from the IRS.
Those penalties won’t just be yours to bear. If your stock options are undervalued, your employees could face a 20% penalty tax in addition to paying back taxes—that defeats the purpose of offering them stock in the first place.
Familiarizing yourself with what a proper 409a process looks like is well worth the time. It’ll help set expectations and give you confidence your 409a valuation provider can deliver an audit-defensible valuation.
In this article:
Here’s a short overview from me about the 409a valuation process:
Your partner should follow similar processes to those I’m explaining below (we’ve completed over 3000 valuations and have always passed IRS audits).
Your starting point is choosing the right 409a valuation consultants to help you.
Day 1: You’ll then do an initial call and share the proper documentation and information with us.
Day 2-8: We then conduct an initial modeling and analysis aligned with IRS rules and your goals, followed by an in-depth review and report creation.
Day 8-10: We send you a draft report, then incorporate feedback and the changes needed.
Let’s look at those steps in more detail:
Time taken: You can choose a provider in as little as 1-2 days.
We recommend looking for these three characteristics:
For more detail, read our guide to the best 409a valuation consultants for hire.
Time taken: 1-2 days (client side)
The first step in working with a consultant will be documentation collection.
This is often a bottleneck—as it takes your team time to collect and prepare information.
At Eton, we request:
Upon receipt of these documents, our side of the process starts. The first thing we’ll do is check we have everything we need. If we don’t we’ll get in touch immediately and make additional requests.
But from here on out your input and effort are minimal. Your consultant will begin their valuation methodology and get back to you within a few days.
Time taken: 1 day (client and valuation firm)
It’s part of our process to understand what prompted your 409a valuation and what stage you’re at as a start-up.
These details will inform the methodologies we choose and determine if we need to fast-track the process to meet deadlines.
We’ll ask you at this point to choose a valuation date. The valuation date is the date on which the fair market value of your company’s stock will be determined.
If you’re not sure what date to choose, we’ll make some suggestions to assist with this choice.
There are a few things we’ll take into consideration when choosing the date, such as if you’re approaching or have just passed a major corporate event, you’re close to the end of the fiscal year, and when you want to issue stock options to employees.
Your 409a is valid for a year from the date of valuation or until a ‘material event’. Material events include financing rounds, terms sheets for financing rounds and acquisitions.
To explore this subject further, read our full guide to choosing your 409a valuation date here.
Time taken: Anywhere from 1-7 days (depending on specified turnaround time)
Once we have your valuation date and we’ve received your documents, the valuation work begins.
This is where advanced methodologies are used to determine your startup’s valuation.
There are three 409a valuation methodologies we use:
Each one adheres to the AICP (American Institute of Certified Planners) published guidance on 409a valuations.
Which one gets applied depends on the developmental stage of your business. For example, a series-a 409a valuation might use a different methodology than a seed-stage valuation.
Generally speaking, early-stage start-ups that have raised funding but aren’t yet profitable will rely on the market approach. Those who haven’t generated revenue and who haven’t raised funds will likely use an asset approach. In both instances, because of the early stage, the company is unable to reliably forecast financials.
The income approach is often applied to businesses that are bringing in revenue with a positive cash flow. They will be able to forecast financials.
We always look to see if one (or all three) approaches fit your situation and will continue to consider them as options throughout the valuation process.
The biggest focus is on your stage of development, cap table, and existing financials.
We’ll also look at:
Each 409A valuation is unique, and the emphasis on these factors can vary depending on the specific circumstances and characteristics of the company being valued. Your company might have considerations that another wouldn’t.
Risk factors can significantly impact the fair market value of a company’s common stock.
Here’s what we look for in every valuation we do:
Early-stage companies, such as Series A or earlier, often face more uncertainty and risk than established businesses that have proven success and tangible data to pull from.
Delivered on: day 7 (by valuation expert)
Your dedicated analyst will prepare the draft valuation calculations which include the methods chosen, assumptions made, data pulled, and the draft fair market value conclusion.
We’ll let you know when you can expect to receive this draft. That way you can reserve time in your schedule to review it.
As soon as it’s completed, we’ll send them to you.
Received on: day 10 (client to review and raise any concerns and questions)
Time taken to finalize: 1-2 days
With your draft report now in your possession, you have the opportunity to review it. Check that you understand the assumptions made and are comfortable with the valuation numbers.
If anything is unclear or you have concerns, you can schedule a call with us and we’ll discuss any issues in detail.
When you’re happy with the valuation, we’ll both sign off on the draft calculation pages.
Then you’ll authorize us to prepare the final report. That final report will be delivered to you within 1-2 days.
Related Deep Dive: How long does a 409a valuation take?
Most of the 409a valuation process is in our hands but of the few tasks you’re responsible for this is what I’d advise:
Having completed so many 409a valuations, we’ve fine-tuned our process to be as smooth as possible for our clients.
If you want to be among them, get in touch here. We’ll deliver a 409a valuation that’s accurate, USPAP compliant, and aligned to your business’s desired outcomes—whatever they may be.
Here are some commonly asked questions we get about the 409a valuation process.
No. 409A valuations are complex and require a deep understanding of financial modeling, tax laws, and market analysis.
You should only ever use a professional analyst from a specialist firm. This way your 409a valuation gets safe harbor status from the IRS, meaning the onus is on them to prove your valuation is inaccurate if audited.
Most companies engage external valuation experts or firms to ensure accuracy and compliance.
Typically, companies will have a 409A valuation at least once every 12 months.
However, if there are significant events such as a new funding round, material change in the business, or substantial financial growth, a new valuation may be needed sooner to reflect these changes accurately.
Read our full guide to 409a Requirements & Compliance.
Failing to perform a 409A valuation can lead to severe tax consequences.
If the IRS deems stock options to be undervalued, employees may face immediate taxation on vested options and an additional 20% penalty tax, plus interest. The company may also face penalties for failing to withhold taxes properly.
Still undecided? Take a read of our article comparing the top 409a valuation consultants for hire for further details on our services.
Schedule a free consultation meeting to discuss your valuation needs.