Choosing a 409A Valuation Provider: What Actually Matters

A 409A valuation is one of those purchases where the cheapest option looks identical to the expensive one right up until it is tested. The report arrives, it has a number in it, the number is low, everyone is happy.

Then an acquirer's tax counsel reads it during diligence and asks how the discount for lack of marketability was derived. Or the IRS examines a grant and asks the company to demonstrate that its strike price was fair market value. At that point, the difference between a defensible valuation and a number becomes very concrete — and the penalty falls on your employees, not on the provider.

This guide covers what the safe harbour actually gives you, how providers differ, when a refresh is required, what the process involves, and what to ask before commissioning one.

1. What a 409A Valuation Is For

Section 409A of the Internal Revenue Code governs deferred compensation. Stock options fall within it, and the consequence is a simple rule: options must be granted with a strike price at or above the fair market value of the common stock on the grant date.

Grant below fair market value and the recipient faces immediate income tax on the discount as it vests, plus an additional 20% penalty tax and interest — on stock they cannot sell. It is a catastrophic outcome for an employee who did nothing wrong, and it is the company's fault.

The valuation exists to establish that fair market value defensibly.

The safe harbour

Where the valuation is performed by a qualified independent appraiser and is no more than twelve months old, with no intervening material event, the valuation is presumed reasonable. The burden shifts to the IRS to show it was grossly unreasonable.

That shift is the entire product. Without it, the company must affirmatively prove its number was right, years after the fact, using whatever contemporaneous evidence exists.

Two other safe harbours exist — an illiquid start-up valuation performed by someone with sufficient knowledge and experience, and a binding formula method — but the independent appraisal route is what almost everyone uses, because it is the cleanest to demonstrate.

2. Why Common Is Worth Less Than Preferred

Founders are frequently confused that their 409A comes back far below the price investors just paid. This is correct and expected.

Preferred stock carries rights common stock does not: liquidation preferences, anti-dilution protection, protective provisions, board rights, and often dividends. Common stock is the residual claim, subordinated to all of it, and it is illiquid.

Appraisers value the whole enterprise, then allocate that value across the classes — usually using an option pricing model, a probability-weighted expected return model, or a hybrid — and then apply a discount for lack of marketability. The result for an early-stage company is typically a common value that is a substantial discount to the preferred price.

A low common value is good for your employees: cheaper options, larger spread, and an earlier start on the QSBS holding period for anyone who early-exercises. What it must be is defensible, not merely low.

3. The Provider Landscape

Cap table platforms with bundled valuation

Most major cap table providers offer 409A valuations, often included in a subscription tier or heavily discounted. They have your data already, turnaround is fast, and the output is standardised.

Good for: the large majority of venture-backed companies with conventional structures.

Watch for: whether the valuation entity is genuinely independent of the software business, how much of the analysis is automated, and whether anyone will actually defend the report if challenged.

Independent valuation specialists

Firms that do valuation work as their primary business, staffed by credentialed appraisers. More expensive, more analytically involved, and more used to being examined by auditors.

Good for: companies with audit requirements, complex capital structures, multiple share classes with unusual rights, imminent exits, or anything a generic model handles badly.

Accounting firms

Many offer valuation services. Convenient if they already know your business — but mind the independence boundary. A firm that audits you generally should not also produce the valuation the audit tests. Our guide to choosing a startup CPA covers where those lines sit.

4. What the Process Actually Involves

Founders treat this as a form-filling exercise and are then surprised when the number comes back higher than expected. The inputs you provide substantially determine the output, and understanding that is worth more than shopping on price.

What you supply. A current cap table with all instruments and their terms, historical financials, a forward financial model or budget, your most recent financing documents and charter, details of any secondary transactions, and a management discussion of prospects — market, competition, milestones, risks. Most providers also ask about expected timing and type of exit.

The projections matter more than founders realise. An enterprise value derived partly from your own forecast means an aggressive model produces a higher common value and therefore a higher strike price for your team. This is not a reason to understate the plan — the same projections may be shown to investors, and inconsistency between the two is exactly what a sceptical reviewer looks for. It is a reason to be realistic in both places and to make sure the two are the same document.

The management call. Usually thirty to sixty minutes, and worth preparing for. The appraiser is calibrating risk: how likely is the plan, what has to happen for it to work, what is the realistic range of outcomes and their timing. Candour about risk here is genuinely useful to you, because a well-supported view of uncertainty is part of what justifies the discount.

Draft, review, final. You should receive a draft and be able to correct factual errors — a misstated share count, a missing instrument, a mischaracterised term. What you cannot do is negotiate the conclusion, and a provider willing to move the number on request is one whose reports are worth less.

Timeline. One to three weeks from complete information. Incomplete cap table data is the usual cause of delay, which is one more argument for keeping the cap table reconciled continuously rather than assembling it under deadline.

5. When You Need a New One

The safe harbour presumption lasts twelve months, or until a material event — whichever comes first. Material events are not a closed list, but the recurring ones are:

• A priced financing round. The clearest possible material event. You need a fresh valuation before granting again.
• A signed term sheet or LOI for an acquisition.
• A significant secondary transaction in your stock at a known price — tender offers in particular, since they establish an observable market price for common.
• A major change in prospects — losing your largest customer, a failed clinical trial, a regulatory decision, a transformative product launch.
• A significant financial deviation from the plan the last valuation relied on.
• A down round or restructuring, which is also the moment you most want a fresh, lower valuation so new grants are meaningful.

The practical operating rhythm for most companies: refresh annually, refresh immediately after any round, and batch grants against the current valuation rather than granting continuously.

6. Questions to Ask a Provider

• Who signs the report, and what are their credentials? Recognised appraisal credentials matter, particularly if an auditor will review the work.
• Which valuation methods do you use, and why? The answer should reference the specifics of your stage and structure rather than a single default approach.
• How do you derive the discount for lack of marketability? This is where thin reports are thinnest, and it is the first thing a sceptical reviewer looks at.
• Have your reports been reviewed by Big Four auditors? If you will ever need an audit, this matters a great deal.
• What is included if the report is challenged? Audit support and IRS examination support should be explicit — in the engagement letter, not in a sales conversation.
• What is the turnaround? Typically one to three weeks. If you need grants approved at a board meeting, work backwards from that date.
• How do you handle SAFEs and convertible notes? Unconverted instruments complicate the allocation, and providers differ in how carefully they model them.
• Are you independent of our auditor and our cap table vendor? Ask directly, and get the answer in writing.

7. Red Flags

• Guaranteeing a low number before doing the work. A valuation whose conclusion was agreed in advance is not a valuation, and any competent reviewer will infer that.
• A report that is mostly boilerplate. Read it. If the analysis specific to your company occupies two pages, that is what a challenger will notice.
• No named appraiser or no credentials disclosed.
• No audit support offered.
• Extreme price outliers in either direction. Suspiciously cheap usually means fully automated with no review; extremely expensive rarely buys more defensibility for a straightforward company.

8. What to Do With the Report

• Board-approve the valuation and reference it in the consent approving grants. The link between the report and the grants must be documented.
• Grant at or above the concluded value. Not near it. At or above.
• Update your cap table system so the strike price on new grants reflects the current number automatically.
• Keep every historical report. Acquirers and auditors will ask for the full series, and gaps in the record are a diligence finding in their own right — see our guide to preparing for diligence.
• Do not circulate it to employees. It contains the company's financial projections. Employees need the strike price, not the report.

Frequently Asked Questions

What happens if we grant options without a valid 409A?

You have no safe harbour, so the company must prove the strike price was fair market value if challenged. If it was too low, affected employees face ordinary income tax on the discount plus a 20% penalty and interest. Remediation is possible in some circumstances but is expensive and unpleasant, and it involves telling your team about a tax problem you created.

Can we use our last round price as the strike price?

You can, and it is certainly safe from a 409A perspective because it is well above fair market value for common. It is also a bad idea — your employees get a much smaller spread, which is a large, avoidable reduction in the value of their equity. Our guide to option pools and employee equity covers the trade-off.

How much should a 409A cost?

Bundled platform valuations for simple early-stage companies are inexpensive, sometimes included in a subscription. Independent specialist work costs meaningfully more and rises with complexity. The right question is not price but what you get if the report is examined.

Do we need one before we have investors?

If you are granting options, yes. A bootstrapped company granting equity to employees has exactly the same 409A obligation as a funded one. Founder stock purchased at formation for a nominal amount is a different situation, addressed in our guide to founder vesting.

Does a tender offer change our 409A?

Almost always. A secondary transaction at an observable price is strong evidence of common stock value and typically constitutes a material event. Expect your next valuation to move toward that price, which is one of the trade-offs of offering employee liquidity.

Can we grant options between the valuation date and the report arriving?

Better not to. The safe harbour attaches to a completed valuation, and granting against a number you expect but have not received is exactly the gap that surfaces in diligence. The clean approach is to align board meetings with the valuation cycle: commission the report, receive it, board-approve it, then approve grants referencing it. Where speed genuinely matters, ask the provider for the concluded value in writing before the full report is finalised — most will do this, and it beats guessing.

What if we disagree with the number?

Raise factual errors immediately — a wrong share count, an instrument modelled incorrectly, a material fact the appraiser did not have. Those are legitimate corrections and providers expect them. What is not legitimate is asking for a lower conclusion because the number is inconvenient, and a provider who accommodates that has produced a report that will not survive scrutiny. If you genuinely believe the methodology is wrong, the answer is a different provider next cycle, not a renegotiated conclusion this one.

How does this work for a company outside the US?

Section 409A applies to US taxpayers, so a non-US company with US employees or a US parent after a Delaware flip generally needs one. A purely non-US company with no US taxpayers does not, but will usually need an equivalent valuation for its own local share-scheme and tax purposes — an HMRC valuation for UK EMI options, for instance, which serves a similar function under different rules. If you have people in both places, expect to need both.

Do we need a 409A for advisor and contractor grants?

Yes. Section 409A applies to options granted to service providers generally, not only to employees, so advisors, contractors and consultants receiving options are covered by the same rule and face the same penalty if the strike price is too low. The common error is treating a small advisor grant as informal enough not to matter — it is the individual, not the company, who pays for that.

The Bottom Line

For most venture-backed companies, a bundled valuation from a reputable provider is entirely adequate. What matters is that it is independent, current, properly board-approved, and supported if challenged.

Refresh after every round, batch your grants, keep the full historical series, and read the report before you rely on it.

Global Capital Network connects founders with investors and with the valuation, legal and accounting firms that support them at our events. If you provide valuation services to venture-backed companies, talk to us about sponsoring or exhibiting.

This article is general information, not tax or valuation advice. Section 409A is technical and the consequences of error fall on individuals. Work with qualified professionals.