What is a 409A valuation, and how does it affect stock options?

Learn how 409A valuations set your strike price, affect your taxes, and impact your option value. Includes free calculator and real employee scenarios.

What is a 409A valuation for employees?

A 409A valuation determines your company's stock value, which directly sets the strike price for your stock options. This independent appraisal happens at least annually and after major events — and it can dramatically impact your equity value and taxes.

Think of it this way: when your company grants you stock options, they can't just pick any price they want. The IRS requires them to use the "fair market value" of the stock, and that's where 409A valuations come in. They provide that official fair market value.

Why 409A valuations matter to you

Here's the reality: 409A valuations directly impact your financial future. They determine what you'll pay for your options and how much you'll owe in taxes. Let's break down exactly how they affect you.

Strike price setting

Your option strike price equals the 409A value on your grant date. This price never changes, even as your company's 409A increases over time. That's why getting hired early, when the 409A is typically lower, can be incredibly valuable.

Example: If you're granted options when the 409A is $2.00 per share, your strike price stays $2.00 forever. Even if the 409A rises to $15.00 by the time you exercise, you still only pay $2.00 per share.

Exercise costs and taxes

When you exercise your options, you pay taxes on the difference between the current 409A and your strike price. The IRS counts this "spread" as income, which means:

• Higher current 409A = higher tax bill when exercising
• Lower 409A at exercise = lower tax bill
• Timing your exercise around 409A changes can save you thousands

Tax example: You have 1,000 NSO with a $2.00 strike price. If the current 409A is $10.00, you'll pay taxes on $8.00 per share — that's $8,000 in taxable income. If you're in the 35% tax bracket, that's $2,800 in taxes just to exercise.

Important note: The exact tax treatment depends on whether you have incentive stock options (ISOs) or non-qualified stock options (NSOs). ISOs can trigger Alternative Minimum Tax (AMT) when exercised, while NSOs are taxed as ordinary income immediately. The examples above show the NSO calculation, but your specific tax situation will vary based on your option type.

For detailed tax treatment, see our complete guides on ISO tax treatment and NSO tax treatment

Capital gains impact when you sell

Here's something most employees don't realize: the 409A value when you exercise becomes your cost basis for future capital gains calculations, not your original strike price. This means 409A timing affects both your immediate taxes AND your long-term tax burden.

How the two-step tax process works (Example)

Step 1 - Exercise (NSO / Ordinary Income Tax):

• You pay ordinary income tax on: Current 409A - Strike Price

Step 2 - Sale (Capital Gains Tax):

• Your cost basis = 409A value at exercise
• Capital gains = Sale Price - Cost Basis (409A at exercise)

Real comparison

• Strike price: $2
• Exercise when 409A = $8:
  • Ordinary income tax: $6 per share
  • Future cost basis: $8
  • Sell at $25: Capital gain = $17 per share
• Exercise when 409A = $20:
  • Ordinary income tax: $18 per share
  • Future cost basis: $20
  • Sell at $25: Capital gain = $5 per share

The strategic insight: Exercising when 409A is lower means that you may pay less ordinary income tax (typically taxed at higher rates) but might pay more capital gains tax later (typically taxed at lower rates). This may often result in lower total lifetime taxes.

Market timing opportunities

The tech market downturn of 2022 created unique opportunities for employees. Many companies saw their 409A valuations drop significantly, creating better exercise timing for employees who had been waiting.

As one example, companies that had 409A valuations based on 50x revenue multiples in 2021 suddenly found themselves valued at 15x revenue multiples. For employees, this meant the spread between their strike price and current 409A shrank dramatically*.

Link to exercise timing guide

When 409A valuations happen

Understanding the 409A schedule helps you plan your equity decisions. Here's when your company must update their 409A valuation:

Required updates

At least annually: The IRS requires companies to refresh their 409A every 12 months to maintain "safe harbor" status. Miss this deadline, and your company risks significant penalties.

After funding rounds: New investment almost always triggers a 409A update, usually within 30-60 days. Since investors typically pay more than the previous 409A, expect your company's valuation to increase.

Before major events: Companies usually get a fresh 409A before going public, being acquired, or during acquisition discussions.

Material business changes: This includes major customer wins or losses, significant partnerships, regulatory changes, or shifts in the broader market that affect your industry.

Employee timing scenarios

Let's address some real situations employees face:

Joining during a funding round

"A startup I'm considering joining offered to grant me stock options. The company raised their most recent round of funding in the spring, and plan to raise another round of funding soon. How will my stock options be valued?"

Here's what typically happens: if your company is actively fundraising, they may be in a "blackout period" where they can't issue new options until the round closes and they get an updated 409A.

Our advice: Ask your recruiter directly if they're in a blackout period. If they are, you might not get your options grant until after the fundraising completes — which usually means a higher strike price.

But here's the bigger picture: if you believe in the company, your team, and your role, don't let 409A timing be the deciding factor. There will be hundreds of people hired after you who wish they had your grant date.

Link to How to negotiate job offer stock options

Companies without VC funding

"I'm applying to a company that gives shares to new employees. It doesn't plan to go public anytime soon, and they're not looking for new investors. How does the 409A work?"

Bootstrapped companies still need 409A valuations if they issue stock options. A third-party valuation company evaluates financial indicators like sales growth and profitability to estimate the company's current worth.

These companies often have more stable 409A valuations since they're not getting the valuation jumps that come with funding rounds. However, they can still see increases based on business performance, industry trends, or if they eventually decide to raise capital.

Key consideration: Bootstrapped companies that eventually raise capital or exit successfully can create significant value for early employees. Think of companies like Mailchimp or Basecamp — no VC funding needed.

How 409A valuations work

Let's demystify the process. Understanding how 409A valuations work helps you make better decisions about your equity.

Who does the valuation

Your company can't just decide their own 409A value. The IRS requires an independent third-party appraiser with at least five years of relevant experience in business valuations, financial accounting, investment banking, or similar fields.

This independence is crucial for "safe harbor" status with the IRS. If the valuation is reasonable and follows accepted methods, the IRS presumes it's correct unless they can prove it's "grossly unreasonable."

Link to IRS Section 409A guidelines

Three valuation methods

Appraisers use one of three standard methodologies:

Market approach (most common)

This method compares your company to similar public companies, looking at metrics like revenue multiples and growth rates. For example, if public SaaS companies trade at 10x revenue, and your company has $10 million in revenue, this approach might value your company around $100 million.

The appraiser then adjusts for factors like:

• Your company's growth rate vs. public comperables
• Profitability differences
• Market position and competitive advantages
• Illiquidity discount (private companies are worth less than public ones)

Income approach

This method projects your company's future cash flows and discounts them back to present value. It's typically used for companies with sufficient revenue and positive cash flow.

Asset approach

Used mainly for very early-stage companies that haven't raised money and don't generate significant revenue. This calculates your company's net asset value — essentially what the company owns minus what it owes.

What impacts your 409A

Several factors can cause your company's 409A to increase or decrease:

Recent funding rounds: New investment usually increases the 409A, sometimes dramatically. The terms matter too — if investors get strong liquidation preferences, it might not increase the common stock value as much as you'd expect.

Public market performance: If public tech stocks are down 70%, it affects private company valuations too. The 2022 market correction led many companies to lower their 409A valuations.

Company financial performance: Strong revenue growth, new major customers, or improved margins can increase your 409A. Losing key customers or missing targets can decrease it.

Secondary market transactions: If employees or early investors sell shares on secondary markets at lower prices, it can impact the 409A.

Industry trends: Regulatory changes, shifts in customer behavior, or new competitive threats can affect entire industry valuations.

Understanding different company values

Your company actually has multiple "values" depending on the context. Understanding these differences helps you make better equity decisions, but it can be confusing.

409A valuation: The fair market value of common stock (what employees get). This is conservative by design and follows IRS guidelines.

Fundraising valuation: What investors pay for preferred stock, which comes with special rights like liquidation preferences and voting control. This is usually higher than the 409A.

Secondary market value: What shares actually trade for on private markets. This often falls between 409A and fundraising valuations.

IPO valuation: The public market's assessment when companies go public.

Why the 409A seems "low": Don't get discouraged if your 409A seems low compared to fundraising valuations. The difference reflects real economic terms — preferred stock genuinely has more rights and protections than common stock.

For a comprehensive breakdown of how private company valuations work and why they differ, check out our complete Private Shares Valuation Guide.

Link to pre-IPO shares

Strategic implications for employees

Here's how to use 409A information to help make smarter equity decisions:

Exercise timing decisions

Monitor the 409A schedule: Ask your company when they last updated their 409A and what events might trigger a new one. If a funding round is coming, you might want to exercise before the 409A increases.

Consider market conditions: During market downturns, companies often see their 409A valuations decrease. This creates opportunities to exercise at lower tax costs.

Factor in AMT: For incentive stock options (ISOs), exercising triggers Alternative Minimum Tax on the spread. Lower 409A = lower AMT hit.

Apply the capital gains strategy: As explained earlier, exercising when 409A is lower typically reduces your total lifetime tax burden by shifting income from higher ordinary tax rates to lower capital gains rates.

Real scenario: In 2022, many tech employees who had been waiting to exercise their options found opportunities when their companies updated 409A valuations downward due to market conditions. Those who exercised during the downturn not only saved on immediate taxes but also set themselves up for higher capital gains (taxed at lower rates) when they eventually sell.

Get a loan to exercise stock options

Job negotiations

Compare strike prices across offers: Two job offers might seem similar, but if one company just raised funding (higher 409A) and the other hasn't (lower 409A), the actual option values could be very different.

Understand equity package timing: Ask potential employers about their 409A update schedule and whether you'll be granted options immediately or after a blackout period.

Factor in company stage: Earlier-stage companies typically have lower 409A valuations, potentially giving you more upside if the company succeeds.

Tax planning

Coordinate with professionals: 409A changes can create tax planning opportunities, but they require careful coordination with tax advisors who understand equity compensation.

Consider multi-year strategies: Instead of exercising all options at once, you might spread exercises across multiple years to manage tax liability.

Plan for AMT credit: If you pay AMT on ISO exercises, you might be able to use AMT credits in future years when your regular tax exceeds AMT.

Link to tax calculator and AMT calculator

What employees should watch for

Not all 409A valuations are created equal. Here are red flags that might indicate problems:

Stagnant valuations

If your company is growing rapidly but the 409A hasn't increased in over a year, it might indicate:

• They're not updating as required
• The business isn't as strong as it appears
• Market conditions are affecting valuations

Unrealistic valuations

Sometimes companies push for artificially low 409A valuations to keep employee option costs down. While this helps employees short-term, it can create problems:

• IRS audits if the valuation seems unreasonable
• Difficulties during due diligence for exits
• Employee disappointment if real value is lower than expected

Delayed updates

Companies should update their 409A within 60-90 days of material events like funding rounds. Significant delays might indicate:

• Cash flow problems (409A valuations cost $1,200-$11,000)
• Internal disagreements about valuation
• Trying to delay higher valuations for employee benefit

Tax and legal considerations

The IRS takes 409A valuations seriously, and the penalties for getting them wrong can be severe.

Safe harbor requirements

To get IRS safe harbor protection, your company must:

• Use an independent, qualified appraiser
• Update the valuation at least every 12 months
• Update after material events
• Follow acceptable valuation methodologies

Link to IRS Section 409A regulations

Penalties for non-compliance

If the IRS determines your company's 409A valuation was unreasonable, employees face harsh penalties:

• All deferred compensation becomes immediately taxable
• 20% penalty tax on all affected compensation
• Interest charges on underpayments
• Penalties apply to current AND previous years

Real impact: An employee with $100,000 in option gains could face $20,000 in penalty taxes plus regular income tax plus interest — potentially doubling their tax bill.

When to seek professional help

Consider working with professionals who understand equity compensation for:

• Complex exercise decisions involving large option grants
• AMT planning strategies
• Pre-IPO tax optimization
• Estate planning with concentrated stock positions

For complex equity situations, Secfi's Equity Strategists can help you navigate 409A implications and exercise timing decisions.

Practical tools and resources

Questions to ask your company

About timing: When was your last 409A update? What events might trigger a new one?

About the process: Who does your 409A valuations? Can you share any summary information from the report?

About policies: What's our exercise window if I leave the company? Are there any blackout periods for option exercises?

Document your decisions

Track 409A values over time: This helps you understand trends and make better exercise timing decisions.

Save all option documentation: Grant letters, exercise notices, tax forms — keep everything organized.

Record your rationale: Write down why you made specific exercise timing decisions. This helps with future planning and tax reporting.

Free resources

Stock Option Tax Calculator: See how different 409A values affect your option value and tax liability

Exercise Timing Planner: Input your situation to get personalized guidance on when to exercise

AMT Estimation Tool: Calculate potential AMT liability from ISO exercises

Frequently asked questions

How often do 409A valuations change?

At minimum, annually. But they often change more frequently due to funding rounds, business milestones, or market conditions. High-growth companies might update their 409A 2-3 times per year.

Can I see my company's 409A report?

Companies aren't required to share the full report with employees, but many will share key information like the per-share value and effective date. It doesn't hurt to ask your HR team or CFO.

What if my company's 409A seems too high or too low?

409A valuations should reflect reasonable market assumptions. If yours seems dramatically off compared to similar companies, it might be worth asking questions — but remember that private company valuations are inherently subjective.

How do 409A valuations affect company culture?

Significant 409A increases can create tension between early and late employees, since late hires get higher strike prices. Some companies address this through refresh grants or other equity adjustments.

What happens to 409A valuations after IPO?

Once a company goes public, they no longer need 409A valuations. The public stock price becomes the fair market value for any remaining option grants.

Should I exercise before or after a 409A update?

It depends on your specific situation, tax implications, and risk tolerance. If you expect the 409A to increase significantly, exercising before might save on taxes — but you're also taking on more risk and tying up capital.

Does 409A affect my capital gains when I sell?

Yes, but not directly. The 409A value when you exercise becomes your cost basis for capital gains calculations. So if you exercise when 409A is $10, that's your cost basis for future sales — not your original strike price. This means timing your exercise around 409A values affects both your immediate ordinary income tax AND your future capital gains.

Link to exercise timing decision framework

The bottom line

409A valuations directly impact your equity value and tax liability. Understanding how they work helps you make smarter decisions about when to exercise, how to negotiate job offers, and how to plan for taxes.

The key takeaways:

• Your strike price is set by the 409A value on your grant date
• Exercise timing around 409A updates can significantly impact your tax bill
• Market downturns can create opportunities for lower-cost exercises
• Not all company valuations are the same (409A, Pref…), understand the differences

Remember, equity compensation is just one part of your total compensation package. While 409A timing matters, don't let it override decisions about joining companies you believe in or exercising options when it makes sense for your overall financial plan.

Ready to optimize your equity strategy? Secfi's Equity Strategists can help you navigate 409A implications, exercise timing decisions, and tax planning strategies. We've helped thousands of startup employees maximize their equity value while minimizing tax liability.