How to Find 409A Valuation

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On this page, we are going to inform you of the best way for your company to find and get a 409A valuation. Also, we are going to inform you when your company needs to get one. Read this text until it’s finished.

Overview

If you have ever started a company, of course you are going to be familiar with the terms “Fair Market Value” (FMV) and “409A”.  Apparently, there is already tons of educational content from the legal community on what 409A is, why it is crucial, and its minutiae. Some people may be sick of reading about the rules by now. Rather than rehash section 409A conceptually, what we are going to try to do in this page specifically is set the best way to find and get a 409A valuation, why, and when your company needs to get one.

How to Find 409A Valuation'

The Best Way to Find and Get 409A Valuation

Below is an explanation about how to find and get a 409A valuation for your company.

The Independent Appraisal Method

The best way to find and get a 409A valuation is through an independent appraisal of the company’s FMV done by the companies like Carta or Scalar. This is called the “Independent Appraisal” method because the law gives the professional appraisal of the FMV (Fair Market Value) of a company’s stock a rebuttable presumption of reasonableness. It means that if the IRS ever audited the company, then the burden of proof would be on the IRS, not the company, for showing that the methodology used was not a reasonable valuation methodology. Dramatically this reduces the likelihood of a successful IRS challenge of FMV (Fair Market Value).

Be Careful Doing It by Yourself

Now, you are able to compare this to if the company used a different method of appraisal, such as doing it by itself.  For this case, the burden of proof will be on the company to show it used a reasonable valuation methodology. Of course, this is expensive, time-consuming, and also highly burdensome to prove.  Even if the company was 100 percent correct, it will need several times and money that the company could invest elsewhere to meet its burden of proof.

Further, the company will run a big risk because it did not use a reasonable valuation methodology. Keep in mind that you are in the business of running your company, not valuing shares of stock.  Therefore, based on your opinion, it is probably not qualified to do so.  By the way, why run the risk, when the adverse consequences are so dire?

Need to note that if you are a brand-new company, say, less than a year old, you may rely on a good-faith valuation of your shares which you do yourself because the shares’ value will be so nominal. But, as you grow, you are able to start considering an Independent Appraisal sooner rather than later.

Your Employees Probably Be Penalized by the IRS the Most for Your Non-Compliance

What is more, the tax penalties for violating Section 409A are not imposed on the firm. They are imposed on the company’s service providers, for example the employees or independent contractors, unless the firm fails to report or withhold any amount which becomes taxable because of a failure to obey Section 409A valuation.

These penalties will include:

  • All vested deferred compensation, for example: options or restricted stock, becomes taxable immediately.
  • An additional 20 percent penalty tax levied on the service provider on the top of regular income tax.
  • Possibility of imposing interest on previous years’ personal equity compensation.

When Your Company Needs to Get a 409A Valuation?

Firstly, you have to know that an Independent Appraisal valuation only lasts 12 months. Thus, your company needs to plan on getting one at least annually if it wants to have the ability to continually issue deferred equity compensation in compliance with Section 409a.

Second, you have to know that the valuation through Independent Appraisal only lasts 12 months if an event which materially affects the value of the corporation has not happened in the interim.

Here are several examples of material events which can re-trigger the company’s obligation to undergo another 409A valuation:

  • The resolution of material litigation. It is mentioned explicitly in the regulations.
  • The issuance of a patent. It is mentioned explicitly in the regulations.
  • A debt or equity financing.
  • Undergoing any type of merger or acquisition.
  • Launching a central product or service of the firm.

Warning: This is a non-exhaustive list. However, it should give you a good idea of what will be considered a material event.

Eventually, the entire 409A valuation process usually takes around two weeks for completing if you are organized and have all your documents ready to go.  But most startups are not, that will be able to extend the process to a month, or longer.  Waiting for a 409A will be able to hold up equity grants that can have a negative ripple effect on your organization.  So, you have to be sure that you are organized and current and also ready for the valuation process.

Section 409A is a really complex law. For this case, we highly suggest you to always consult with an attorney if you have any questions. Here, this post is only for informational and educational purposes. Of course, it is not intended to give any legal advice.

The last word, we are going to inform you that there are two more methods set in Section 409A. Those two methods are the Formula Valuation and Start-up Company Valuation.  While valid, apparently these are more difficult to comply with and honestly, we do not praise them as highly as the Independent Appraisal method.

Well, the text above is an explanation about how to find and get a 409A valuation, when your company needs to get a 409A valuation, and other information related to a 409A valuation. If you want to get more information about a 409A, you are able to read other articles on our site.

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