409a Valuation Requirements | How Often & When – FAQs

In this article, we’ll walk you what’s required of your company when it comes to 409A valuations—so you stay compliant and avoid 409A penalties.

TL;DR – Quick Takeaways

  • There are 5 basic legal requirements your valuation must meet (explained below).
  • You’re required to complete a 409A valuation every 12 months.
  • You’re required to complete a 409A sooner than 12 months if a material event occurs (material events are explained below).
  • 409a valuations should take fewer than 10 days depending on the process of your provider.
  • For you and your employees to avoid 409A penalties you must adhere to 5 requirements. These include using an independent specialist and maintaining thorough documentation (detailed below).

Legal IRC 409A Valuation Requirements You Must Meet

To qualify for the “Safe Harbor” under IRC Section 409A, every business that completes a 409A valuation must adhere to the same requirements.

These are:

Requirement 01:

“Ensure that incentive equity is offered to employees pursuant to a written 409A valuation assessment.”

What it means: The valuation must be a written report.

Requirement 02:

“409A valuations must be updated on the earlier of every 12 months, or the occurrence of a “material event”.”

What it means: Valuations expire after 12 months, if not already expired due to new information material to the company’s value.

Requirement 03:

“Must update their 409A valuation on the occurrence of material event.”

What it means: A valuation becomes invalid the moment it fails to reflect all available information that is material to the value of the company.

Requirement 04:

“Use an independent specialist to complete each 409A valuation.”

What it means: The valuation must be performed by a qualified individual.

Requirement 05:

“Valuing your business through the use of a “reasonable” valuation method.”

What it means: Your valuation provider must take into account all available information that could affect your company’s valuation. They should apply that information consistently to determine valuations regardless of the purpose.

Why Is a Safe Harbor Important?

A “safe harbor” means your valuation is considered valid and defensible by the IRS. The beauty of the “safe harbor” is that, once achieved, you shift the burden of proof to the IRS. If they ever decide to challenge your valuation, it’s on them to prove your stock exercise price was less than FMV on the date the grant was issued.

When is a 409A Valuation Required for Startups?

Three main instances trigger the need for a 409A valuation:

  • First: When a startup wants to offer stock options to their employees.
  • Second: When they experience a material event. 
  • Third: In the absence of a material event, startups should get a new 409A valuation every 12 months.

A ‘material event’ is anything that changes the value of that company, such as:

  • Financing rounds
  • Mergers
  • Acquisitions
  • Major changes to the business model
  • Major changes to market conditions (e.g. COVID-19 pandemic or market crash.) 

409A valuations are required pretty early on in most startups because most want to incentivize their employees with stock options and make sure that they comply with tax law when doing so.

409A Valuation Frequency: How Often is a 409A Valuation Required?

If you are granting stock options and want to comply with tax law, you must complete a 409A valuation every 12 months (or sooner if a material event occurs). 

Why 12 months? Over a year, a company can undergo various changes that might affect its value – such as growth in revenue, changes in the market, or new product launches.

More frequent valuations could theoretically provide a more accurate reflection of a company’s fair market value at any given moment, but they would also be more burdensome and costly for companies.

An update every 12 months makes 409a valuations more practical while still offering a regular update to fair market valuation.

Important: Update Your 409a When a “Material Event” Occurs

If you experience a material event before those 12 months are up, you’ll need to complete another 409A valuation. The 12-month rule will then apply to your most recent 409A valuation.

Let’s say you offer stock to your employees in March. You will need a 409a valuation done before granting the stock options in March to tell you the market value of that stock. The next valuation wouldn’t be due until March of the following year.

However, if you raise Series A that September, then you’ll need to complete a second 409a valuation before granting any stock options. A new valuation would then be due 12 months later.

How Much Time Does a 409a Valuation Take? What Steps Are Involved?

how long does a 409a valuation take?

An accurate 409a valuation can take anywhere from 10 days to 1 month, depending on the consultant you use.

It can be completed faster but most quality 409a valuation providers will charge additional fees to expedite the process.

Our standard 409a valuation process takes 10 days upon receipt of the company’s documents.

Read our in-depth guide to How Long a 409a Valuation Takes here.

The Typical Process (What’s Required of You?):

our 409a valuation consulting process

At Eton Venture Services, our 409a valuation process begins with data collection and a one-on-one consultation. Both help us understand your company’s position and needs. 

At that point, our valuation experts conduct initial modeling and analyses aligned with industry guidance and your goals. 

That’s followed by an in-depth internal review and report creation (all of which is done by us—no requirement from you).

On day seven or eight, you’ll receive a copy of the draft report and we will ask you to provide feedback. 

Once we’ve incorporated any feedback (and walked you through the analysis if you prefer), a finalized 409A valuation report will be sent to you for use no later than day ten.

What Data and Documentation Do We Require From You?

Having the correct company data and documentation is a critical part of creating an audit-defensible 409A valuation. 

Luckily, most companies already have the data and documents organized from other events, such as venture financing.

The documents we require are:

1. Financial Statements

Financial statements (including income statements and balance sheets) offer a snapshot of your company’s financial health and performance. They are crucial for evaluators to understand your business’s current financial position and historical performance.

2. Financial Forecasts

Forecasts project future revenue, expenses, and growth. They help our valuation experts assess the potential future path and future value of your company, which is a key factor in determining the fair market value of your stock.

3. Capitalization Table

The capitalization table provides a detailed breakdown of your company’s ownership structure, including the classes of equity, the number of shares outstanding, and the number of options granted.

Many cap tables also capture details such as the original issue price and date of issuance. This information is vital to understand the distribution and value of equity, which directly impacts the valuation.

4. Articles of Incorporation

This document, also known as a “Charter”, is a legal document that officially recognizes a company as a corporation. It outlines key details like the corporation’s name, purpose, structure, and stock information, and is essential for the legal operation of the business. Because it provides fundamental information about the company, it provides a legal baseline for the valuation, ensuring that the valuation adheres to the legal framework of your organization.

5. Business Plan; Investor Presentation Deck

The deck you show to investors provides insight into your business model, market potential, growth strategy, and how you present your company to external stakeholders.

This helps our valuation experts gauge market position, market opportunity, and growth potential.

6. Convertibles (SAFE Notes, Convertible Debt, KISSs, etc.)

Convertibles like SAFE notes, convertible debt, and KISSs are financial instruments that may convert into equity in the future, impacting your company’s capital structure.

These agreements are crucial for understanding potential equity obligations and their influence on your company’s valuation.

7. Straight Debt (if applicable)

Straight debt includes standard loans and credit lines that impact your company’s liabilities. Understanding these financial obligations is crucial for an accurate valuation, as they directly affect the company’s net worth.

409a Valuation Budget Requirements – How Much Will One Cost You?

A 409a valuation with Eton will cost you between $2500 and $4000 (most clients pay around $3000). The cost is dependent on the stage of your business and the complexity of your capitalization table.

Interested in a full breakdown of 409A valuation costs?

Read our article: How Much Does a 409A Valuation Cost? Prices in 2024

When The Company Gets Sued

In our legal analysis of Wilson vs. Safelite, we look at who suffers when 409a valuations are done incorrectly.

Read the full article here (it should give you an indicator of why 409a compliance matters).

409A Valuation Requirements For Avoiding Penalties

To avoid IRS 409a valuation penalties you must:

  • Complete a 409A every 12 months or whenever a ‘material event’ takes place: This ensures the valuation is up-to-date and reflects the current fair market value of the company’s stock.
  • Use an independent specialist to complete the 409A valuation: An independent appraiser or a qualified internal resource ensures objectivity in the valuation process.
  • Follow reasonable methodologies that are USPAP compliant: Adhering to the Uniform Standards of Professional Appraisal Practice (USPAP) guarantees the valuation meets professional standards.
  • Document the valuation process: Maintain thorough documentation of the valuation process, assumptions, and conclusions to defend the valuation if audited by the IRS.
  • Consider all relevant information: The valuation must take into account all available information material to the value of the company, including financial data, market conditions, and business prospects.

Let’s take a look at each of these in more depth.

Avoiding 409a Penalties #1: Update Your Valuation When Needed

One of the most critical aspects of a 409A valuation is adherence to the Internal Revenue Service (IRS) rules.

Are you issuing stock options, or have outstanding stock options that could be exercised? Failing to complete a 409A valuation every 12 months or immediately after a material event can lead to significant penalties.

Avoiding 409a Penalties #2: Use an Independent Specialist

Using an independent specialist for your 409a valuation is a safeguard against penalties.

409a valuation consultants who are experienced and well-versed in IRS guidelines ensure that your valuation is compliant and withstands scrutiny. It’s the easiest way for startups to guarantee safe harbor and compliance.

Most startups, particularly those without the internal resources or expertise to navigate these complex valuations, would benefit from the services of an independent, qualified specialist.

Get Compliant: Insider Tip

Make sure that your independent qualified appraiser produces a written report and s/he signs the appraisal or valuation report. I know those two seem obvious but you would be surprised by how many firms decide to not sign their reports

Avoiding 409a Penalties #3: Follow Reasonable Methodologies

There are three reasonable methodologies for conducting a 409A valuation:

  • Market approach
  • Income approach
  • Asset approach

Following and applying these methods is essential for a 409a valuation.

Quality valuation consultants typically utilize these reasonable methods under USPAP, which provides a framework for quality control in appraisals, generally contributing to the credibility of a valuation.

These methodologies enhance the credibility of a valuation. But ultimately, it’s the adherence to IRS standards and guidelines that is crucial for the valuation to be considered compliant and within the safe harbor. 

IRS 409a Penalties: What Actually Are They?

The penalties for non-compliance can include:

Tax Implications for Employees: Employees might face immediate tax liabilities on their stock options, which is a situation most startups want to avoid.

Monetary Penalties: The IRS can impose fines that could be substantial, depending on the degree of non-compliance.

Legal and Reputation Risks: Beyond financial penalties, legal challenges and a damaged reputation can have long-term effects on your startup’s growth and ability to attract talent and investment.

The easiest way to avoid penalties on your 409A valuation is to choose a valuation provider who:

  • Uses reasonable methodologies
  • Doesn’t use automated valuation methods
  • Offers safe harbor status 
  • Has years of experience completing 409A valuations
  • Has a legal background ensuring an accurate understanding of tax law and the most recent Tax Court cases 
  • Hasn’t lost a single IRS audit

Ultimately, you want a valuation provider who provides you with a valuation that fits into the safe harbor every time.

This is huge because having 409A valuation safe harbor means your valuation is presumed valid unless the IRS can prove it is grossly unreasonable.

When your 409A valuation doesn’t qualify for safe harbor status, you have the burden to prove that it is reasonable if the IRS challenges it.

With Eton, clients always get a 409A valuation that fits into the safe harbor.

409A Requirements – Common Pitfalls You Should Avoid

We often see companies make these mistakes (and get penalized for it):

  • Misconception about desiring low stock values for granting options: Many companies mistakenly aim for the lowest possible stock value to grant cheap stock options. This approach can lead to significant compliance issues and potential legal and financial repercussions, as it might contravene the fair market value requirements of Section 409A.
  • Improper timing and granting of options: Ensuring that stock options are granted at no less than fair market value on the date of the grant is critical. Mishandling this can result in significant non-compliance issues with the IRS. Get your 409A first, and then grant your stock options pursuant to its conclusion.
  • Non-compliance with the “Safe Harbor” methodology: Adhering to accepted valuation methodologies, like independent appraisals, is essential for compliance. Deviations from these methods can lead to serious consequences.
  • Lack of documentation: Keeping thorough records is crucial. Inadequate documentation of the valuation process and data used can be problematic, especially during audits.
  • Ignoring material events: Failing to reassess the company’s valuation immediately after a significant event can result in outdated and unacceptable valuations by the IRS.
  • Inappropriate use of historical data: Using outdated financial data can lead to incorrect valuations, making this a significant concern.
  • Neglecting to reassess valuations regularly: Regular reassessment, at least annually and after material events, is required to ensure ongoing compliance with IRS expectations.

How to Choose a 409a Valuation Provider

When choosing a 409a valuation provider you want three things:

  • Competitive costs
  • Quality services
  • Compliant valuations

That way you don’t have to overpay for an accurate valuation and you can avoid a cheaper option that leaves you susceptible to penalties from the IRS. 

At Eton, we offer all three. 

Not only do you get the same quality valuation you would at one of the big 4 firms, but you get a faster and more attentive service from our team at a fraction of the cost.

Want to get started on your 409a valuation with a trusted, compliant provider? 

Get in touch with us here.

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President & CEO

Chris co-founded Eton Venture Services in 2010 to provide mission-critical valuations to venture-based companies. He works closely with each client’s leadership team, board of directors, internal / external counsel, and independent auditor to develop detailed financial models and create accurate, audit-proof valuations.

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