You may wonder whether the 409A valuation is public or not. Well, if you want to know about this information, you are able to read it below together with some other information about the 409A valuation.
Is a 409A Valuation Public?
You may want to know whether a 409A valuation is public or not. According to the Visible site, the answer is no. On that site, it is also explained that a 409A valuation is not public and the reason is because it is only available to privately held companies. Furthermore, it is explained that to be able to get a fair market value appraisal, a startup needs to look at publicly traded companies in their space for a comparison.
What Is a 409A Valuation?
According to the Inc site, a 409a valuation is an appraisal of the fair market value of your startup company’s common stock. If the stock is traded publicly, it will be easy to see the specific prices for any given time of the day. However, for private company stock, an independent valuation is needed to see how much your company stock is worth.
According to the Balance, here is the explanation about a 409a valuation. It needs to be appraised for private companies that want to issue shares to their workers. There are a lot of reasons a company may want to offer shares of stock to employees. Let’s take an example. There are a lot of companies which will offer stock to their workers as an incentive. If employees are part of the company, it can help them feel truly invested in their work. Stock options are also able to be a good way for an early-stage company to give compensation to workers if it is not able to afford to pay higher salaries right away.
Whatever the reason is, a company which wants to offer shares to employees needs to get a 409a valuation. It needs to be done every 12 months or at every round of funding.
The Way a 409A Valuation Works
According to The Balance, here is an example of how a 409a works.
- Let’s say that a new employee is hired by company A and the company offers them the option to purchase 1,000 shares of stock at the current fair market value. Let’s suppose that each share is worth $1 at this point in time. The price is the strike price.
- The employee is told by the company A that they are able to ‘exercise’ that option after five years of working at the company and it is known as the ‘vesting period’. It is important for you to note that the vesting period at companies can vary.
- Then, five years goes by and shares are now worth $30 per share. Cited from The Balance that the employee exercises their option to purchase 1,000 shares at $1 each. In essence, $1,000 is paid by them for something worth 30 times that.
- The employee is able to keep the stock or sell it at $30 per share and make a profit.
As explained on The Balance, for this situation, a 409a valuation is important to determine the option price being offered to employees. There, it is also explained that the IRS does not want companies to make up a valuation simply, while employees surely want to purchase shares at the lowest price possible.
The Way to Get A 409A Valuation
According to The Balance site, here is the explanation about the way to get a 409a valuation. Hiring an outside firm is a recommended way to do an appraisal. It is because that group has the ability to determine fair market value by examining the financial statements of the company. Analysing the company’s cash flows, assets or both may be done by the firm. Performing comparisons against companies of the same size in the same industries may also be done by the firm.
There are software programs and it is available to help you determine fair market value yourself where it may save your company money. However, it is important for you to note that if you do that, it is riskier than hiring an outside firm since you may not be eligible for something called ‘safe harbor’. Let’s say that you get safe harbor. If so, the IRS is required to accept your valuation unless it is able to prove it to be unreasonable. Where is the burden of proof placed? It is placed on the IRS. In general, it is difficult to get safe harbor status unless the valuation is done by a qualified third party.
If you hire an outside firm to perform your 409a valuation, it will take roughly a month. If you run the actual report, it may take a few weeks and you need to account for time to gather your important data and any important revisions.
Factors That Influence Your 409A Valuation
According to the Inc site, the firms will usually take one of the approaches below to be able to appraise fair market value.
- Market Approach
This is an analysis of comparable private and public companies and transactions.
- Income Approach
This is an analysis of a company’s free cash flows to determine projections for the next five years.
- Asset Approach
This is an analysis of a company’s tangible and intangible assets.
The Length of the 409A Valuation Process Takes
Cited from Inc site, here is what a typical time frame is when dealing with a valuation firm according to Capshare.
- Submit your data where it takes around 1 to 3 days.
It will include your cap table, articles of incorporation, financial projections, term sheets, and past 409a reports.
- Run the report where it takes around 10 to 20 days. Do you want your valuation quicker? If so, you can expect to pay at least $1,000 to $3,000.
- Review first draft where it takes around 15 minutes to 1 hour.
- Revisions where it takes around 1 to 2 days.
- Final report is delivered where it takes around 1 to 10 days.
The Things That Will Happen If You Do Not Have a 409A Valuation
According to the Inc site, if you do not price your stock options, it can be bad. It is because the IRS sees that as giving away something valuable and it can cause a big tax problem.
If there are any option holders which violate 409A, they will need to pay taxes plus a 20 percent federal penalty, any applicable state penalties, an IRS tax underpayment penalty, and any interest on unpaid taxes.
It is likely that most startups will not encounter a 409A audit from the IRS. However, if your startup becomes successful and begins making money, an IRS audit will be a greater possibility. It will be time consuming and expensive.
Besides, you may face serious questions from the Securities and Exchange Commission which looks at pre-IPO stock awards.