A 409A valuation is an independent appraisal of a private company's common stock fair market value — required by the IRS before granting stock options — with non-compliance carrying severe tax penalties.
At CRAGSI, we define a 409A valuation as an independent appraisal of the fair market value of a private company's common stock, required under Section 409A of the Internal Revenue Code before a company can grant stock options or other equity-linked compensation. Non-compliance — granting options at a below-market exercise price without proper valuation support — triggers severe penalties: immediate income recognition, a 20% excise tax, and interest.
Every venture-backed company that grants stock options needs a 409A valuation — typically at least annually, and whenever a "material event" occurs (a new financing round, significant change in business prospects, or capitalization change). The valuation must be performed by a qualified independent appraiser using IRS-approved methodologies.
409A valuations are more complex than they appear. Common stock in a venture-backed company is typically worth significantly less than the preferred stock price — because preferred stock has liquidation preferences, anti-dilution protections, and other features that make it more valuable in most exit scenarios. The appraiser must apply an option pricing model to allocate total enterprise value across the capital structure and arrive at a defensible common stock value.
CRAGSI provides 409A valuations for early-stage and distressed companies, with particular expertise in situations where standard methodologies are complicated by financial distress or complex capital structures.
Related CRAGSI service: Valuations