Hi, I’m Chris Walton, author of this guide and CEO of Eton Venture Services.
I’ve spent much of my career working as a corporate transactional lawyer at Gunderson Dettmer, becoming an expert in tax law & venture financing. Since starting Eton, I’ve completed thousands of business valuations for companies of all sizes.
Read my full bio here.
You started your tech company a few years ago with a vision to disrupt an industry. You’ve been heads down building the product, hiring a stellar team, and raising money from savvy venture capitalists who share your vision.
The business is growing fast, and it’s time to offer stock options to attract and retain top talent. But issuing options comes with IRS rules you need to follow, including obtaining an independent 409A valuation to establish the fair market value of your common stock, the 409A price.
This 409A valuation is different from your VC valuations and funding rounds. It’s a necessary compliance step, but also a chance to gain valuable insight into how an objective outsider views your company’s worth.
A 409A valuation is an independent assessment of the fair market value of a private company’s common stock. It is required by the IRS when issuing stock options to ensure the strike price is not set below market value.
The valuation reflects what a willing buyer would reasonably pay for the company’s common shares at a specific point in time. It uses the company’s financials, market conditions, growth prospects (but cautiously and only if they’re well supported), and capital structure to determine that price. Because common stock is less liquid and carries fewer rights than preferred stock, the value is typically discounted.
Companies usually hire a third-party 409A appraiser to perform the valuation using standard methods like discounted cash flow, market comparables, or recent financing rounds. A 409A is valid for 12 months or until a material event, such as a new funding round, occurs.
The result is used to set compliant strike prices on option grants and protect employees from tax penalties.
For an early to mid-stage startup, you can expect to pay $5,000 to $10,000 for a 409A valuation with a household name provider. With Eton, our 409A valuations always cost between $2,500 and $4,000.
Learn more about this topic by reading our article on the cost of 409A valuations.
| Type of Valuation | Purpose | Subject | Methodology | Typical Outcome |
|---|
A 409A valuation is a conservative estimate of what your company’s common stock is worth today. It’s based on your current financials and market conditions, and it’s used to set the strike price for employee stock options (mainly for IRS compliance).
A venture capital (VC) valuation, on the other hand, is the price investors are willing to pay for preferred shares, which come with extra rights like liquidation preferences. It’s usually much higher, because it’s based on where the company is going, not where it is today. Investors factor in growth potential, not just current numbers.
Some of the factors that may lead to differences in the two valuations include:
In summary, 409A valuations and VC valuations serve very different purposes and rely on different assumptions.
While a high VC valuation is a reason to celebrate, a 409A valuation is meant to reflect the fair market value of your company’s stock for tax and compliance purposes. Both play an important role in the startup ecosystem.
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A 409A valuation reflects the private fair market value of common stock, while an IPO price reflects what public investors are willing to pay for the company’s shares.
The 409A valuation is used to set the strike price for employee stock options. It is based on the company’s current financials, applies discounts for illiquidity and risk, and assumes the company will remain private for the foreseeable future.
The IPO price is set when the company goes public and is influenced by investor demand, market conditions, and future growth expectations. It is not limited by tax or compliance requirements and often reflects a much more optimistic view of the company’s potential.
For example, in a hypothetical scenario, Airbnb’s last 409A valuation before going public may have been under $50 per share. Its IPO opened at $146 per share.
The gap between the two reflects their purpose. The 409A is for compliance and employee option pricing. The IPO price is driven by what the public market believes the company is worth.
A 409A valuation reflects what your common stock is worth today. A post-money valuation reflects what investors are willing to pay for preferred shares based on future expectations.
Post-money valuation is calculated after a funding round by dividing the investment amount by the ownership stake the investor receives. It sets the paper value of the company and is based on the preferred stock price agreed during the deal.
Preferred shares carry rights like liquidation preferences and anti-dilution protection, which make them more valuable than common shares. That value is baked into the post-money number.
A 409A valuation ignores these preferred terms. It focuses on the current state of the business and applies discounts for risk, illiquidity, and the fact that common shares have fewer rights. That’s why the 409A valuation often comes in much lower.
If a company raises $10 million at a $40 million pre-money valuation, the post-money is $50 million. But the 409A valuation of common stock might fall between $10 and $15 million. This isn’t a mismatch but is instead a result of the different goals behind each valuation.
A 409A valuation estimates the fair market value of common stock, while the preferred price is what investors pay for preferred shares during a funding round.
Preferred shares typically come with added rights and protections. These can include liquidation preferences, anti-dilution clauses, board seats, and priority in payout if the company is acquired. Because of these advantages, preferred stock is more valuable than common stock and commands a higher price.
The preferred price is set through negotiation between the company and its investors. It reflects the perceived upside of the company and is often based on future growth expectations, not just current performance. This price becomes the basis for the company’s post-money valuation, but it does not apply to common shares.
In contrast, a 409A valuation applies discounts to reflect the lack of these rights, lower liquidity, and higher risk associated with common stock. That’s why the common stock price in a 409A valuation is usually significantly lower than the preferred price, even at the same point in time.
⚠️ Note: In public markets, a “strike price” refers to the set price at which options can be exercised—either to buy (calls) or sell (puts) a stock. In startups, it specifically refers to the price an employee pays to purchase common stock under their equity grant. This price must be at or above the fair market value determined by a 409A valuation.
A 409A valuation determines the minimum legal strike price for employee stock options.
The strike price is the cost an employee must pay to exercise their options and purchase common stock. By law, the strike price cannot be lower than the fair market value of the common stock on the date of the grant.
That fair market value is set by the 409A valuation. If the company skips this step or sets the price too low without proper documentation, employees risk tax penalties under IRS rules.
In most startups, the company completes a 409A valuation to establish a compliant strike price that gives employees meaningful upside. A lower 409A means a lower strike price, which increases the potential gain if the company grows or exits later.
So while the strike price is the number written into an option grant, the 409A valuation is what makes that number valid.
A 409A valuation is an independent analysis of your company’s fair market value. It aims to determine an objective, supportable value of the common stock for tax and compliance purposes.
In contrast, a VC valuation is established through negotiations between your company and potential investors to determine the price of preferred stock that typically has more rights and privileges than common shares.
While it is theoretically possible for a low 409A price could influence venture capitalists during negotiations, such a situation is quite unheard of as VCs understand the purposes of a 409A price and the factors used to estimate it.
VCs conduct their own due diligence to assess your company’s potential and growth opportunities to establish an investment value range. They will consider factors like:
In addition to the factors above, there are some quantitative reasons for differences in conclusions between the two approaches. Some of the main differences include:
Rather than relying on your 409A report, VCs will evaluate your company’s unique attributes and risks to determine a financing offer that balances their potential return on investment with your funding needs.
It matters to VCs that you have hired third party valuation firms to estimate your 409A price because VCs care about complying with laws.
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As a private company, you’ll need to obtain an independent 409A valuation to determine the fair market value of your common stock for the purpose of setting exercise prices for stock options and restricted stock units (RSUs).
The 409A valuation provides an objective assessment of your company’s worth based on its assets, financials, growth projections and other metrics. It differs from a venture capital (VC) valuation, which focuses primarily on a company’s potential for high future returns.
You’ll require a 409A valuation in several situations:
A 409A valuation provides an objective, defensible assessment of your company’s fair market value at a point in time based on its assets, financials, competitive position and growth prospects.
Because the IRS considers it a safe harbor, a properly conducted, independent 409A valuation can minimize the risk of adverse tax consequences from option grants and other share issuances. While a VC valuation focuses on future potential, a 409A valuation analyzes the company as it exists today.
Related Read: Check out this Real 409A Valuation Report Sample
Schedule a free consultation meeting to discuss your valuation needs.
Chris Walton, JD, is is President and CEO and co-founded Eton Venture Services in 2010 to provide mission-critical valuations to private companies. He leads a team that collaborates closely with each client’s leadership, board of directors, internal / external counsel, and independent auditors to develop detailed financial models and create accurate, audit-ready valuations.
