A 409A valuation is important if you have a company, including a startup or a big company. For those who are planning to get a 409A valuation for your company, you might be wondering about its accuracy. So, how accurate are 409A valuations?
No one knows how accurate the 09A valuations are. This one is not necessarily an accurate valuation of what the true valuation of a company is when it goes to raise money from investors in the arm’s length negotiated transaction.
As you probably know, there are a total of three ways to get a 409A valuation. Those include:
If you are confident that you are able to do the valuation by yourself, go for it. However, you need to make sure that you have knowledge, experience, education, as well as training to perform a 409A valuation. This method is fine for the eligible companies.
If you are considered as an expert and are good at the field of valuation, performing a 409A valuation by yourself is good as it will save the money in your pocket. Not only that, the benefit includes having much higher control over the valuation of the common stock of your company. However, you might find a hard time depending on yourself in case there is any mistake or if there is an IRS audit. Another minus point of performing a 409A valuation by yourself is you would not get the safe harbor protection. In fact, it is only possible for the company to be able to get the safe harbor status if the 409A valuation is performed according to the IRS rules, which is usually performed by the third party professional. If you do not use a third party professional, you will have to prove the valuation of your company when the IRS makes a visit to audit your company.
- Using software valuation
The next method to get the 409A valuation is to use valuation software. One of the good things of using the software applications is that there will be no need for you to spend a lot of time getting the final valuation. For your information, the normal 409A valuation takes weeks to months until you get the results. Not only that, the money that you would have spent on the professional appraiser can be saved.
On the internet, there are a total of two kinds of software applications that can be found. The first one is free while another is paid. If you want to save money, you can use the first one. However, if you want to get a more accurate valuation for your company, using the second one is recommended.
Aside from offering some advantages, the method of using the valuation software also has some drawbacks. By using this method, you will not be able to get safe harbor protection. Besides, you will also have to prove the validation of your company just in case the IRS comes to audit your company. In addition, this kind of software is not the kind of one that can be used easily. To be able to use it, you may have to fit specific criteria for the inputs of the company data so that it can make sense for the ultimate valuation. This aspect may be the reason why it is not the best option to use.
- Expert consulting from a valuation service provider
In addition to these two, the last one that can perform a 409A valuation is expert consulting from a valuation service provider. If you prefer this method, you can hire a professional valuation service provider. If you are wondering how much does it cost for you to use their service, you are suggested to contact them and discuss the details.
Compared to the first two, this one is the most expensive. However, it is worth it as it offers a few things that others don’t. One of the things that you will get by using this method is the safe harbor status. By having it in hand, there will be no need for you to prove the valuation of your company when the IRS makes a visit to audit your company. Basically, this method is best to reduce the risks when it comes to the safe harbor status and any possible penalties from the IRS.
The last option, which is hiring an expert from a valuation service provider is the best one. This one is believed to be the most accurate compared to the other two. Not only that, it is also known to be a safe harbor method. If the company does not use this method to determine the value of its stock, the valuation that it gets is considered not valid. When it comes to the audit, the company has to prove that its valuation is reasonable. Proving that its valuation is reasonable is not easy. It may require producing financial documentation from around the time of its option grants.
Aside from that, choosing not to use this method to determine the fair market value when making equity awards may increase the deal friction when raising financing or at the time of an exit, which is an acquisition or an IPO. The main reason is because compliance with Section 409A can be the point of legal and tax scrutiny.
If a company uses this method, then the valuation that it gets is considered valid. By using this method, the company does not have to prove that its valuation is reasonable. The only one that has a job is the Internal Revenue Service. Its job is to show that the valuation is grossly unreasonable, which is known to be a high threshold.
Once again, the accuracy of the 409A valuation depends on a few things, including the one that makes the valuation. As stated before, the best one is the one that is done by a professional. There are a lot of service providers that you can consider if you want to hire such a professional to do the job making a 409A valuation. While you need to spend money, it is worth it.