Guide
409A valuation vs fair market value: the same number, different burden
Updated
Founders often ask which number to use, the 409A or the fair market value. The regulation does not offer that choice. A 409A valuation is a method of arriving at fair market value, and what you are buying is the presumption that comes with it.
Talk to a specialist Nine 409A valuation providers, the four that publish a price, the five that will not, and what each says about turnaround, audit support and who signs the report.
Fair market value is the standard. The safe harbour is the proof.
For stock that is not readily tradable on an established securities market, the regulation defines fair market value as "a value determined by the reasonable application of a reasonable valuation method" (26 CFR 1.409A-1). That is the standard, and it applies whether or not anybody has been engaged to appraise anything.
What an independent appraisal buys is not a different number. It is a presumption that the number was reasonable, and with it a change in who has to argue about it.
The three presumptions the regulation actually lists
The regulation sets out valuation methods that are presumed reasonable. Two of them are available to almost any private company; the third is written for early-stage companies specifically.
- Independent appraisal
- "A valuation of a class of stock determined by an independent appraisal that meets the requirements of section 401(a)(28)(C) and the regulations as of a date that is no more than 12 months before the relevant transaction". This is the route most venture-backed companies take.
- A nonlapse restriction formula
- A valuation based on a formula that would be treated as fair market value if used as part of a nonlapse restriction. Narrow in practice, because the formula has to bind consistently rather than only when convenient.
- Illiquid stock of a start-up corporation
- A valuation "made reasonably and in good faith and evidenced by a written report" of illiquid start-up stock. The written report is not optional, and this route carries conditions on the company's stage and the valuer's experience.
How long a 409A valuation is good for
Two things end it, and the second is the one companies miss. The regulation treats a valuation as failing where it "was calculated ... more than 12 months earlier than the date for which the valuation is being used", and equally where it "fails to reflect information available after the date of the calculation that may materially affect the value of the corporation".
So the answer is not simply twelve months. It is twelve months or the next material event, whichever arrives first. A priced round, a signed term sheet, a significant acquisition offer, a large customer win or loss, or a change in the company's projections can all end a valuation early while it is still months inside its date.
The twelve-month figure is a ceiling, not an entitlement. A valuation dated ten months ago that predates a Series B is not a valuation you can grant options against, and the regulation says so in the same sentence that gives you the twelve months.
What this changes about choosing a provider
If the number is fair market value either way, the provider is not being bought for the number. They are being bought for whether the appraisal meets the conditions attached to the presumption, and for how quickly they can re-run it when a material event lands before the twelve months are up.
That reframes the two questions worth asking a provider: does the engagement include a re-valuation on a material event, and what is the turnaround when one happens. A cheaper annual price with a slow or chargeable refresh is not cheaper if the company raises.
What this page does not say
It does not tell you the consequence of getting it wrong, which is a matter of section 409A itself and of the individual's tax position rather than the company's (26 U.S.C. 409A), and it is not advice about your grants. It quotes the valuation rules in the regulation and stops where they stop.