409A Valuation   

A 409A valuation provides a company with the fair market value of common stock. This valuation will allow you to issue equity-based compensation to employees at fair market value, including stock options, restricted shares, and other share-based equity instruments. Newer companies that issue equity-based compensation often have intricate capital structures with various classes of stock and equity awards. Often, complex methods are required to value common stock in the context of complex capitalization.

The Purpose

Private companies intending to provide equity-based compensation to their employees generally need a 409A valuation. This ensures their compliance with IRC Section 409A's safe harbor provisions. The issuance of such compensation should be at or above fair value to prevent hefty tax penalties. These penalties can include a 20 percent federal income tax penalty and varying state tax penalties. Conducting a 409A valuation guarantees that you sidestep major tax penalties related to incorrect issuance of equity-based compensation. It is necessary to carry out a fresh 409A valuation whenever there's a significant corporate event, such as:

  • Securing a funding round

  • Major shifts in leadership roles

  • Significant modifications to business operations or plans

  • First revenue generation or profitability achievement

  • Expiration of a previous 409A valuation that's more than a year old

Redwood Advantage for 409A Valuations

Avoid automated providers who prioritize growth over service and expertise, leading to potential tax penalties and misevaluations. At Redwood, we offer accurate, timely, and well-informed valuations that withstand the scrutiny of auditors and regulators, reflecting your company's risks and development stage. Our specialization in valuation ensures superior standards and technical proficiency. Our team, with diverse backgrounds in venture capital, corporate finance, and start-ups, has completed thousands of 409A valuations. We pride ourselves on our holistic approach, exceptional service, and defensible independence.

FAQ

We’ve helped hundreds of startups and established businesses complete valuations. Here are some common questions.

  • A 409A valuation report remains valid for up to 12 months from the valuation date or until a significant event – such as a new funding round.

  • A draft 409A valuation is typically ready for review within 3 to 4 weeks, but we have expedited options for timelines as short as one week. For later-stage companies, the process might take a bit longer.

    ‍Upon receiving your report, you can assess the valuation for its accuracy. We are happy to connect with you and your auditor at any point throughout the process.

  • Companies issuing stock options or other equity compensation, including most startups, need a 409A valuation.

    ‍When granting stock options to employees, determining the fair market value of the stock is necessary to set the exercise price for those options. For public companies, the exercise price is the stock price on the date of grant. For private companies, the easiest way to grant options to your employees on a tax-free basis is through an independent 409A valuation.

  • Non-compliance could lead to harsh financial implications for your employees. If the IRS determines your 409A valuation does not meet standards, all the shares granted to employees at that value could be subject to gross income tax. The IRS can also impose a penalty of up to 20% on stock options in addition to back-tax.

    ‍Although enforcement cases are uncommon, the IRS has successfully prosecuted cases in the past (see Credit Karma). 409A compliance is a part of due diligence for every investor and potential buyer. The absence of a compliant report can hinder or deter future investment.

  • The 409A valuation process broadly involves three steps:

    Estimate company value: For high-growth, cash burning tech companies, the market approach is commonly used. In the absence of a recent round of funding, you and/or your valuation firm identify public companies in your sector and applies the selected valuation multiples to the relevant company metrics.

    Ascertain the value of the common stock: The next step involves allocating the company value to the different share classes. This can be complex due to the differing economic rights of different shares (such as preferred shares).

    Apply a Discount for Lack of Marketability (DLOM): Since the company's shares aren't tradable if it's private, your auditor applies a discount to your share price due to the absence of a liquid market for these shares.

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