You may be confused to specify the effective date of a 409A valuation if you do not consider selecting a valuation date. Remember that a 409A valuation will be valid for a maximum of twelve months, after the effective date or until a material event. Well, let us dive into our page to know what the effective date of a 409A valuation is!
What is a Valuation Date in 409A Valuation?
Valuation date is the time the business being valued is assigned a value (price in $). The term “valuation date” is used when an asset requires to be valued before it is sold or distributed, or the worth of the asset is periodically estimated for reporting. As per the IRS, the 409a valuation process needs a valuation date. Remember that the valuation date is not the same day as the report delivery of the 409A valuation.
Selecting a Valuation Date for 409A Valuation
Selecting a valuation date needs you to consider many situations. This is in order for each of the situations that can affect the valuation.
Here are some of the questions to ask yourself for different situations:
- When you close your recent funding round
One question you have to ask yourself if you are selecting to fund your business with venture capital is when you close a recent funding round. Usually, the valuation date will be the same as that day or after, because you are going to have all the data which you need for the valuation of the company. A main benefit offered by this method is that it will ease the process of valuation. However, this can also act as a disadvantage in many cases.
The point made here is that by imputing the value of regular shares on a recently priced preferred share. The entire thing becomes formulaic. This method can be good. It is the preference of a majority of investors to value companies. If the valuation is done well and immediately after the rounds, then it is a good sell. However, as more and more time passes from the funding round, the opportunity of things changing increases. This is because since the funds were invested in the firm, things change, and so the price of the shares and options.
- End of an accounting period
You need to ask yourself after you need a valuation is when the end of the accounting period. If the accounting period is closed, then you are able to give relatively accurate financials. If your business closes its books on a monthly basis, there is no need to worry, you are able to use the most recent month to close the valuation date. If the books are closed quarterly, the last closed quarter must be the valuation date. If the books of the company are closed annually, then several accounting and finance resources need to be introduced because you are going to need more recent and better information regarding the company. Here you have the choice of selecting the date when the period ends.
- When you will issue stock options
Another question you have to ask yourself is when you will issue stock options. This is because the normal catalyst of a 409A valuation is the firm’s need to issue options. They have to be issued at the fair market value as such to avoid any issues with tax. The valuation will be valid for one year from the 409A valuation date, so the price you get will be valid for the next 12 months for issuing stock options, except if any material events happen before then. For your information, a material event includes a big change in the prospectus of the company such as the financial structure, equity capital raise, and also other major events.
Example of a 409A Valuation Date
Well, let us take an example of Buzz Ltd. They are a business which is looking to issue stock options to their employees. To do that, they are needed to get a 409A valuation done to decide the price of the stock options. Now, they are considering the valuation date, by remembering all factors which affect the selection of a valuation date such as the end of the accounting period. Buzz Ltd saves their accounts in Quickbooks that are updated monthly. They are able to select the date depending on when they are willing to issue the stock and when the books are updated. Since a 409A valuation is valid for 12 months, the company will be able to select June 30th (end of Q2) as its valuation date or if its books are updated regularly, the end of July.
Relation between Fair Market Value and Effective Date of 409A Valuation
The fair market value (FMV) estimate is as of the valuation date and management selects this date. For instance, you start a valuation on July 5, and then finish it on July 18, however the valuation date requested by management can be June 30. This will allow the company to give financial information up to that date, because July financials will not yet be available. Fair market value (FMV) will change every day the company is in operation due to all types of factors such as the cash in the bank, economic conditions, the competitors, sales and so on.
It is crucial to note that while fair market value (FMV) changes every day, a 409A Valuation becomes invalid after a significant change in the value of the firm.
Here are some examples of significant events:
- A round of funding
- Closing a major deal
- A new product launching with high growth
- FDA approval of a product or drug
But, the IRC does not give any guidance about significant events or not. It means that after a round of funding the company needs another 409A valuation before issuing more options. If your grant date is after a round of funding, then the strike price should not be based on a 409A Valuation dated before the round of funding.
