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 409A valuations for startups of all stages.
Read my full bio here.
Ever read about 409A valuations and been left scratching your head? The convoluted explanations, the legal jargon…rest assured, you’re not alone.
It’s a complex topic, and we want to make it simple. We legal folk tend to make things appear WAY more difficult than they need to be, so this “For Dummies” guide is long overdue.
We’ll also jazz up this long read with anecdotes and real-life examples from companies like Stripe & Instacart—who had disasters we can all learn from.
The guide below is broken into six parts:
🧱 Part 1: 409A Valuation Basics (Perfect for Newbies)
🤿 Part 2: Diving Into The Details of 409A Valuations
😲 Part 3: When 409A Valuations Go Wrong – Horror Stories & Lessons
💰 Part 4: 409A Valuations For The CFO
🧑🎓 Part 5: A 409A Valuation Expert Answers Your FAQs
📚 Part 6: 409a Valuation Resource Library
Just click the links above to jump straight to the sections most relevant to you.
Keep a look out for the 📌(pin). It’s there ‘pinning’ a TL;DR (too long, didn’t read) snippet at the beginning of almost every section. That way, even if you skim-read, you’ll still get value.
Disclaimer: There will be some jargon, but when it’s introduced we’ll provide a clear and simple definition.
In this section, you’ll learn:
A 409A valuation is a formal report that determines the fair market value (FMV) of a company’s common stock.
This valuation is necessary for companies that issue stock options, stock appreciation rights, or other equity-based compensation plans to their employees.
It’s meant to ensure stock options granted by a company to its employees are issued at a price that is compliant with the Internal Revenue Code (IRC) Section 409A in the United States.
📖 Fair Market Value (FMV): A key concept in finance and economics, referring to the price at which a property or asset would sell under normal market conditions. In the context of 409A valuations for startups, FMV is the estimated price at which the company’s common stock would change hands between a willing buyer and a willing seller, with both having reasonable knowledge of all pertinent facts and neither being compelled to transact. |
📌 TL;DR: After financial scandals where the IRS suspected tax avoidance, they introduced Section 409A in 2004 to prevent companies from undervaluing their common stock options.
🤔 Tell me more:
When you were younger, did you ever have a rule imposed on you because of something another kid did? For example, I know someone whose entire school district got banned from the Pennsylvania Renaissance Faire after one kid broke a tree (don’t ask me how).
Well, the introduction of 409A is a bit like that.
IRC Section 409A came in response to financial scandals committed by a few corporate organizations, most notably Enron.
These scandals brought to light the manipulations of deferred compensation plans and stock option grants. Before this, companies often granted stock options “in the money” (below the current market price), which was considered an incentive for employees but raised issues of fairness and tax avoidance.
And so the IRS cracked down and in 2004 enacted Section 409A. Instead of being banned from the Renaissance Faire, all startups who offer common stock options must now prove they’re at fair market value.
📌 TL;DR: Start-ups often find 409A requirements costly, complex, and a general hindrance—it’s yet another thing they have to worry about as a business to be tax compliant. That said, compliance is important to them.
🤔 Tell me more:
Here are some of the biggest complaints I’ve heard about Section 409A:
But even if 409A compliance feels like a burden, it’s helping keep organizations honest about the value of their company which is only a good thing for the wider market. And compliance, when you consider the risks and benefits, is worthwhile.
📌 TL;DR: 409A valuations which are Section 409A compliant prevent you and your employees from facing penalties from the IRS, lawsuits, and repercussions from a poor business reputation.
🤔 Tell me more:
409A compliance keeps you and your employees who receive stock options or restricted stock units (RSUs) from facing major tax consequences.
Proper valuations also:
Luckily, there’s a system in place that makes these benefits easy to obtain. Under Section 409A, the IRS outlines routes to what they call a ‘Safe Harbor’.
📖 Safe Harbor: Safe harbor refers to a set of IRS guidelines that, when followed, provide a presumption that the valuation method used to determine the fair market value of a company’s stock is reasonable. This presumption protects the company and its employees from adverse tax consequences. There are 4 routes to safe harbor status:
For more information: 409A Valuation Safe Harbor Guide – Incl. Risks & Penalties |
The simplest way to secure a safe harbor for most businesses is the first route: An 409A Independent Appraisal Presumption. It involves hiring a reputable, independent third-party valuation firm who will complete the valuation on your behalf.
📌 TL;DR: There are three moments when a 409A is required:
🤔 Tell me more:
409A valuations are first required when a private company, usually a start-up, first offers common stock options to its employees. This is usually done as an incentive, reward, and as a means of attracting top talent. We call this the
From that point, the 409A valuation will need to be updated every time the company experiences a material event. In the absence of a material event, the 409A valuation needs to be completed every 12 months.
📖 Material Event: A material event refers to a significant event or change within a company that can impact its financial position or stock value. For more information: 19 409A Valuation Material Event Examples |
Examples of material events include:
In this section, you’ll learn:
📌 TL;DR: At Eton, we take anywhere from one to ten days to complete your valuation and follow a simple 6 step process:
If you want a full breakdown, you can read our full guide on the 409A valuation process.
🤔 Tell me more:
Every 409A valuation consultant will have their own process and timeline. Some companies can take months to complete a 409A valuation for you while firms like Eton have perfected a 10-day turnaround. We can complete the process in as little as one day but that comes at a premium cost.
Related read: How long does a 409a valuation take?
Below I’ve outlined our six-step process and provided the timeline associated with those steps.
Time taken: As little as 1-2 days.
The first step of the process is to find a 409A valuation provider and confirm with them the service and timeline you require.
Try to avoid 409A valuation providers who use automation in their process as this can jeopardize safe harbor status and leave your company susceptible to penalties.
Top tip: Ask your lawyer who they recommend. It’s a great way to find a firm that is experienced. Most Eton clients are referred to us by their lawyers because they trust our expertise and have seen the outcome of our services before.
You can also check out our list of the best 409A valuation consultants for hire.
Time taken: 1-2 days (client side)
Before your 409A valuation firm can begin the valuation process from their side, they need to collect company information which they’ll use to inform which methodologies they apply and to help them complete those chosen methodologies.
At Eton, we request:
Top tip: This is the step that causes the most delays. To avoid this, have your documentation organized ahead of time.
Time taken: 1 day (client and valuation firm)
It’s important to speak with your valuation company so that you get a custom experience with advice. This is also the time you’ll choose a valuation date.
Your valuation date isn’t necessarily the date the report is finished but rather the date your company has been valued against.
Top tip: Work with your valuation firm to determine a date that is convenient and keeps you compliant.
Time taken: Anywhere from 1-7 days (depending on turnaround time)
With your valuation date chosen, the required documents in hand, and specific needs discussed, your valuation firm can begin the actual process of valuing your company.
This process will include choosing and applying methodologies. At Eton, every client has a dedicated analyst and project manager to make sure the process is smooth and without error. We’ll also have the calculations checked internally.
Top tip: Sit back and relax! This is all in our hands now.
Delivered on: day 7 (by valuation expert) if following a 10-day turnaround.
Once we’ve completed the valuation and modeling, you’ll receive a draft report for your review.
Want to know what a report looks like? You can check out our free 409A sample report.
Top tip: Set aside time in your schedule to review the documents.
Received on: day 10 (client to review and raise any concerns and questions)
Having addressed any issues in the draft report, this is the point in the process where both client and firm sign off on the final report. The firm will literally sign it while the client will accept it as the final version.
📌 TL;DR: There are 3 valuation methodologies accepted by the IRS as reasonable:
You can and should have multiple valuations applied to your valuation.
🤔 Tell me more:
Methodologies are how you determine the value of your common stock. Whatever method is used must be deemed ‘reasonable’ and be ‘reasonably applied’. A reputable 409A valuation will guarantee this happens and at the same time secure you the safe harbor we mentioned earlier.
Three methodologies adhere to AICP (American Institute of Certified Planners) guidance and thus meet the criteria in Section 409A.
These methodologies are:
Each of these methodologies has its strengths and is chosen based on the specific circumstances and characteristics of the company being valued.
The key is to apply the methods consistently and logically, providing a realistic assessment of the company’s fair market value.
Where possible, firms should take a hybrid approach as it can derive a more accurate valuation. For example, a company might use both the income approach and the market approach to triangulate a fair valuation.
📌 TL;DR: If you’re found non-compliant to Section 409A, your employees will face significant tax penalties (20%) on top of needing to pay the owed tax and accrued interest.
As a result, employers can face expensive lawsuits from those employees and a damaged reputation in the eyes of investors, clients, and potential hires. Yikes.
🤔 Tell me more:
Non-compliance with 409A is a risky business, one that’s just not worth the hassle.
There are both direct and indirect consequences should the IRS audit your company and find you’re missing a 409A valuation when you should have one or have undervalued the value of your common stock.
There are plenty of places for a 409A valuation to go wrong. It could be that you hire the wrong firm, withhold important financial information, or simply don’t have your documents readily available.
In my 20-year career, I’ve seen it all. To make the 409A process as seamless as possible and to help you ensure compliance—without overpaying—here’s what I suggest:
Ensure that all financial data, including revenue, expenses, cash flow, and projections, are accurate and reflective of your company’s current and future financial health. Accurate financials are the foundation of a reliable 409A valuation.
If your company possesses unique assets, intellectual property, or proprietary technology, make sure these are well-documented and highlighted. Such assets can significantly impact your company’s valuation.
Be aware of current trends, economic conditions, and market dynamics in your industry. These factors can influence your company’s valuation, and being informed will help you understand and contextualize your 409A valuation results.
Keep detailed and organized records of all financial transactions, cap tables, previous valuations, and material changes in the company. This practice not only aids in a smoother valuation process but also provides necessary documentation for auditors and investors.
And it means updating your valuation will be a breeze.
Be realistic about your company’s value. Overestimating can lead to unfavorable tax implications for employees, while underestimating can raise red flags with the IRS and potentially undervalue your company in the eyes of investors.
Utilize one of the safe harbor methods for your 409A valuation. This typically involves getting a valuation from a qualified, independent appraiser, which the IRS is less likely to challenge.
Compliance is so much easier when you hire a firm specializing in 409A valuations, like Eton or similar. They can provide an objective, market-based assessment of your company’s value. Expert firms are familiar with the nuances of 409A requirements and can help navigate the complexities of the valuation process.
And you don’t need to pay a substantial amount to secure an expert firm with a proven track record. At Eton, our services start at a reasonable $2.5K.
In this section, you’ll learn:
Because companies need to complete 409A valuations at least every year, it’s normal to see slight variations in the value of that company over time. Material events are much more likely to cause a dramatic change, whether that be an exciting rise in value or a staggering fall.
In this section, we’re looking at three companies who saw their valuations falter in the face of material changes and what we can learn from them.
Expand the items below to read on:
Stripe, founded in 2010 and a major player in the fintech industry, experienced a significant valuation cut as recently as 2022.
After a 409A valuation, its valuation was reduced by 28%. This reduction was triggered by the general downturn in the stock market, a ‘Material Event’ impacting many businesses.
Lesson Learned: Stripe’s case shows how external economic factors can heavily influence a company’s valuation.
That’s why companies need to be aware of market conditions and brace for their potential impact. But it’s not all bad news—this devaluation could mean a lower tax burden on stock options for employees and if the company can maintain a strong revenue, this could be a great time to attract new talent.
In a similar vein, Instacart’s valuation took a nosedive following its 409A valuation in 2021. The company’s value plummeted from $39 billion to $24 billion, a 38.5% decrease much like many others.
Lesson Learned: Instacart’s story serves as a reminder of the dynamic nature of business valuations and that some material changes aren’t relegated to one sector and instead are indicative of larger trends.
The company’s valuation adjustment, while substantial, was an objective response to market shifts.
This stresses the need for businesses to stay adaptable and responsive to changing market conditions to avoid a similar devaluation.
When Elon Musk acquired Twitter for about $44 billion in 2022, the whole world watched with bated breath to see what he’d do with it.
Some applauded the changes he made while most looked on in horror. Mass layoffs, a questionable rebrand, and deplatforming journalists—just to name a few.
It wasn’t shocking then that a year on from Musk’s takeover, a new 409A valuation pegged the company at just $19 billion.
This drastic reduction was, to some extent, attributed to Musk’s leadership style and decisions.
Lesson Learned: Unlike Stripe and Instacart, whose valuation changes were largely driven by market dynamics, Twitter/X’s story suggests a significant influence of leadership and strategic decisions on company valuation.
It emphasizes the crucial role leadership plays in a company’s financial and operational health. Who you are as a leader matters.
Now we wait for future 409A valuations to see if X holds at this new low or bounces back—and if so, why.
In this section, you’ll learn:
📌 TL;DR: Due to the nature of their role, CFOs need to be aware of 409A compliance requirements, prepared to identify material events that trigger updates to the valuation, budget for the cost of these valuations, and prepared to translate these valuations to other stakeholders.
🤔 Tell me more:
As CFO, you’ll be a key stakeholder throughout any company valuation process. After all, you’re the steward of your company’s financial practices, including compliance with IRS regulations like Section 409A.
But what exactly is your role here and how can you be prepared for it? This section is for you:
A material event, in the context of 409A valuations, is any significant occurrence that could impact your company’s financial status or the value of its stock.
This includes events like a substantial funding round, a major change in business model, a significant product launch, or a drastic shift in market dynamics.
Your role involves continuously monitoring for such events and understanding their potential impact on your company’s valuation.
While the actual valuation is often outsourced to expert firms, you’ll have a role in selecting a reputable valuation firm and communicating with them.
You need to ensure they have all the necessary information and understand the nuances of your business. This includes providing comprehensive financial data, insights into the company’s prospects, and any relevant market analysis.
Once the valuation is completed, interpreting and contextualizing the results for your board, investors, and employees is key.
This requires a deep understanding of the methodologies used and the ability to explain how external and internal factors have influenced the valuation.
Beyond compliance, the 409A valuation has strategic implications.
It affects how stock-based compensation is perceived internally and externally.
Your role encompasses integrating valuation outcomes into broader financial planning, compensation strategy, and even in discussions with potential investors.
Rigorous documentation can help prove compliance and make future valuations easier.
If you’ve secured safe harbor then you won’t have to worry too much because the IRS will be responsible for the audit and will be required to prove non-compliance if they suspect it. But in the event you don’t have safe harbor, accurate record-keeping could be your saving grace.
Part of your role involves educating your board and employees about the implications of 409A valuations.
This includes clear communication regarding the impact on stock options and overall compensation, which is crucial for maintaining trust and morale within the company.
Staying up to date on any changes in tax laws and regulations related to deferred compensation and 409A valuations is essential.
This foresight allows for proactive adjustments to valuation strategies and compensation structures.
Finally, ensuring that the costs associated with regular 409A valuations are accounted for in the company’s budget is a practical aspect of your role.
This includes understanding the trade-offs between cost, quality, and risk in the selection of valuation service providers.
Hi, I’m Chris Walton, author of this guide and CEO of Eton VC. I’ve spent much of my career working as a corporate transactional lawyer at Gunderson Dettmer, becoming an expert in tax law.
Now, I put that expertise to use helping my team complete 3000+ 409A valuations for 1000s of clients across industries and all stages of their start-up journey.
Below I’ve answered a few common questions I see regularly asked about 409A valuations.
Expand the items below to read on:
A 409A valuation is typically valid for 12 months, assuming no significant events occur that could materially affect the company’s value.
However, if there is a material event before the 12-month period ends, such as a new round of financing, a significant change in the business, or a major economic event, a new 409A valuation will be necessary.
Limited Liability Companies (LLCs) might need to perform valuations similar to 409A valuations, especially if they have a form of equity compensation (like profits interests).
However, the specifics can differ:
A common myth is that only large or mature companies need 409A valuations.
In reality, any company granting stock options needs a 409A valuation to ensure compliance.
Some believe that the valuation determined in a funding round can be used for 409A purposes.
However, these valuations often differ as investor valuations are forward-looking and speculative, while 409A valuations focus on current fair market value.
Some think that a 409A valuation is a one-time need. However, it’s an ongoing requirement as long as the company continues to grant stock options.
There’s a misconception that 409A valuations only impact preferred stock. In fact, 409A valuations primarily determine the value of common stock for option pricing.
While stock options are a primary focus, 409A valuations also apply to other forms of deferred compensation.
Hungry for more? Check out these resources from our 409A Valuation Library where we cover different aspects of 409A valuations in depth.
And here are the external sources we mentioned in the guide:
Schedule a free consultation meeting to discuss your valuation needs.
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.
