What is a 409A valuation, and how does it affect stock options?
15 min
San Francisco native (yes, really). @uw and Lowell High alum. I like to nerd out on fintech, stock options and taxes.
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San Francisco native (yes, really). @uw and Lowell High alum. I like to nerd out on fintech, stock options and taxes.
You might know that a 409A valuation is the foundation of any stock grant, but understanding its role in how and when to exercise your options is another matter entirely.
Ongoing valuations will affect your equity journey in many different ways, for instance:
If you want to help optimize your exercise strategy, you need to understand the role of the 409A valuation and how it can change over time.
That's why we've written this article. In it, we're covering:
A 409A valuation is an independent appraisal of a private company's common stock. The IRS requires that any startup that issues stock options perform these at least once a year, or whenever there is a major event such as a new funding round.
Another common terminology for the 409A is the fair market value (FMV).
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 match the strike price to the current FMV, and that's why they need up-to-date 409A valuations.
Your company also can't just decide its 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."
Read the official IRS rules to learn more.
There are many factors that can cause your company's 409A to increase or decrease. The ones you should know about are:
Although all 409As must follow strict regulations, there are three different methods that appraisers can use to determine the company's final value.
They are:
This method compares your company to similar public companies, looking at metrics like revenue multiples and growth rates. This helps inform an appraiser about the potential worth of your company should it go public tomorrow.
For example, if a public SaaS company in the same industry traded 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:
This method projects your company's future cash flows, then discounts them back to the present value. It's typically used for companies that already have established revenue and positive cash flow.
This method is mainly used for very early-stage companies that haven't raised much funding and don't yet generate significant revenue. It works by calculating your company's net asset value, which is essentially what the company owns minus what it owes.
Here's the reality: if you have been granted stock options, then your company's 409A valuations directly impact your financial future. It determines what you'll pay for your options and how much you'll owe in taxes.
Let's break down exactly how a 409A valuation affects you:
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: if your company grows in the future, you'll have access to shares at a fraction of the fair market value.
For example, imagine you're granted options when the fair market value is $2.00 per share. No matter what happens to the company, your strike price will remain at $2.00 forever. Even if the 409A rises to $15.00/unit by the time you exercise, you still only pay $2.00 per share.
As we'll explain below, the strike price also acts as a base point for both your exercise and sale tax obligation. It is one of the most important elements of stock options, and is fully determined by the 409A valuation at the time of grant.
A lot of people don't realize that exercising your stock options can come with a significant tax bill. Especially if you haven't planned ahead for it.
This is because when you exercise ISOs or NSOs, you pay taxes on the difference between the current 409A fair market value and your strike price. The IRS counts this "spread" as income, which means:
For illustrative purposes only. Actual results may vary and there is no guarantee of any particular outcome.
For non-qualifying stock options (NSOs), this is taxed at your ordinary income rate, but ISOs deal instead with Alternative Minimum Tax (AMT). This is a separate system designed to make sure high-income earners pay enough in taxes. What's pertinent to you is that the ISO spread is taxed with AMT, whereas it is not with the normal system.
If you exercise any amount of ISOs, you have to work out both your normal taxes and AMT, then pay whichever is higher. The good news is that there are ways to reduce your AMT obligation, or avoid triggering it altogether.
This is how timing your exercise around 409A changes can save you thousands (if not more).
The recent SpaceX IPO is a great case study for this. A Californian-based employee was granted 100,000 ISOs at a $4.40 strike price in 2019. She decided to exercise all her options in 2024 with a 409A valuation of $30/share. That was a spread of $15.60/unit, and she paid approximately $924k in taxes.
That might seem high, but if she had waited until 2026 to exercise, the exercise would have been a lot more expensive. Before the company IPO-ed, the 409A valuation was set at $105/share. That would have resulted in $3.5M in taxes, three times what she actually paid.
This case study is an illustration of our capabilities provided to an individual client. Client results may vary, and there can be no guarantee of similar results. It is not known whether the client approves or disapproves of Secfi Advisory Limited or its affiliates as a whole.
With stock options, not only do you have to pay tax on the spread at exercise, but you'll also usually be taxed on any gains you make when you sell your equity. And those gains are determined as anything above your strike price.
So, whatever your 409A valuation was when you first received your grant will be reflected in the strike price, and used as the cost basis for your gains.
If you're liquidating pre-IPO shares, the 409A valuation plays yet another role: it will determine your sales price.
For instance, say you exercised 50,000 options at a strike price of $2.50/share. Some time later, your company decides to do a tender offer, and based on its most recent 409A valuation, offers to buy back your shares for $10/share.
You would then be liable to pay tax on your profit of $7.50 per unit, or $375,000 total. The exact tax rate depends on many factors, which you can read more about here: What is capital gains tax for stock options?
For illustrative purposes only. Actual results may vary and there is no guarantee of any particular outcome.
Understanding your company's past, current, and potential future 409A valuations should inform your stock options strategy. Spotting the signs and knowing the trends will help you make decisions around when to exercise and whether or not to sell.
Here's how to use a 409A valuation to your advantage depending on these situations:
If you're considering two (or more) offers, then the 409A valuation can be a useful data point. Two job offers might seem similar, but if one company just raised funding (and a higher 409A) and the other hasn't (with a lower 409A), the actual option values could be very different.
The equity package timing also plays a part. You could ask potential employers about their 409A update schedule and whether you'll be granted options immediately or after a blackout period.
You can also factor in the company stage, remembering that earlier-stage companies typically have lower 409A valuations, potentially giving you more upside if the company succeeds.
An upcoming 409A valuation can inform your stock options strategy in several ways.
If you suspect the valuation is going to go up, then exercising now could be a financially savvy move. As you're taxed on the spread, waiting until the FMV is higher will result in a higher tax bill. Whereas exercising now will result in the same number of shares, but a lower total exercise cost.
If you want to exercise now, but don't want to fund it with your own capital, then non-recourse financing could be a good fit. It will cover the entire exercise cost (including taxes) and assume the liability should the shares end up worthless. On a successful exit, you'll pay back a portion of your gains to the lender (on top of the principal and interest).
A company growing rapidly but without a 409A increase is not a cause for alarm per se, but it could mean different things. Of course, it could be that the company is not growing, but it could just be simply that market conditions are allowing the 409A to stay stagnant. A lower 409A does benefit executives and employees personally given their equity stakes.
If you haven't already exercised your stock options, it might be worth waiting to see if there is an increase soon before making a decision.
If the 409A valuation has stagnated or dropped due to certain external factors, it can actually create a good opportunity for employees.
A real-world example is the tech market downturn of 2022. Many companies saw their 409A valuations drop significantly, meaning a lower cost to exercise for employees who had been waiting, as their tax obligation became dramatically lower.
Making these kinds of decisions can be extremely difficult without experience seeing valuations rise and fall. We always recommend speaking to a professional for help navigating your personal decision whether or not to exercise.
A changing 409A valuation can inform your stock options strategy, but it can't tell you exactly what to do. Plus, we know that upcoming valuations can add time pressure to already difficult decisions around exercising and selling your options.
We built the Secfi platform to make this process simpler and easier. Our founders were tech employees with upcoming valuation events and stock option grants they wanted to exercise, but not the cash or confidence to do it. They had to walk away from their equity and didn't want other tech employees to have to do the same.
Now our services help people navigate stock option exercising with advice, insights, and financing. Here are the features that might benefit you:
Maeve is our purpose-built AI equity assistant, designed to help you better understand your stock options grant. You can connect your account to Carta, upload your documents, or manually input information to get instant personalized insights based on Maeve's existing knowledge of your company's most recent 409A valuation.
Based on this information, you can use Maeve to model future equity scenarios and make more informed decisions on what to do with your options right now. Maeve can help with:
Maeve is free to use and will remain a resource for you at every step of your stock options journey.
Trying to spot the trends in your company's 409A valuation when you haven't seen a startup go through a successful exit in the past is challenging. You have limited points of reference, and it's normal to feel uneasy when you're facing a significant financial investment through exercising.
But our wealth specialists have seen it all before. They have helped thousands of employees navigate equity strategies and know exactly what to watch out for when it comes to company valuations.
Working with a member of the Secfi wealth team can help take you beyond just understanding your stock options grant by also accessing direct advice and a personalized wealth strategy. They can make changes that reflect your personal needs and ensure that the stock options planned are aligned to your specific financial goals.
Following 409A patterns can help you identify the best time to exercise your options. But that can lead to a second problem: not having the cash to fund it.
We know this frustration all too well, with our founders having faced this exact problem before building Secfi. So they came up with a solution: non-recourse financing for stock option exercises.
Unlike traditional financing, we will fund the entire cost of your stock option exercise without your personal assets being on the line. If your equity loses value, you don't owe us anything back. If your company has a successful IPO, then you'll repay us from your gains plus a portion of your upside.
We're focused specifically on startup employees and tech executives, and have done more deals by number than any other provider. However, we're also highly selective with who is approved for non-recourse funding. Get started to find out if you might be a fit.
409A valuations can be used to track how your company is growing, and how likely a successful IPO is in the future. The better you understand it, the easier it will be to create a stock options plan that you feel confident in.
The easiest way to do this is to use resources like Maeve to break down what your company's valuation and liquidity events mean for you, or work with a professional to determine the right strategy for your vision of the future.
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 multiple times per year.
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.
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 and there's a benefit to keeping the value low.
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.
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.
Yes, but not directly. The 409A value when you exercise becomes your cost basis for capital gains calculations. So if you exercise NSOs when the 409A value 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.