What a 409A valuation actually does
A 409A valuation (named for the Internal Revenue Code section that requires it) is an independent appraisal of your company's common stock fair market value. That number becomes the strike price for stock options you grant—the price an employee pays to exercise. Preferred stock, which investors buy, is valued separately and is almost always worth more than common, so the 409A number is typically lower than your last financing price per share.
Why you need one before granting options
If you grant options with a strike price set below fair market value, the IRS can treat the difference as immediate taxable income to the option holder—plus a 20% penalty tax, plus interest—even though they haven't sold anything or received any cash. A current 409A valuation creates a safe harbor: if you rely on it in good faith, the IRS presumes your strike price was reasonable.
Who performs it and when
- Independent valuation firms: Carta, Aduro, and similar providers run 409A valuations for a fee, typically a few thousand dollars depending on complexity.
- Timing: Get a new 409A after every priced financing round, and at least once every 12 months even without a financing—the safe harbor expires after 12 months or sooner if a material event (a new round, a major new contract, a significant change in business) makes the old number stale.
- Board approval: The board formally approves the 409A report before it's relied on for option grants.
The trap: a signed term sheet can make your 409A stale overnight
A 409A doesn't only expire quietly at the 12-month mark. The more common way it goes stale is a signed term sheet landing on your desk before the round has actually closed—before any money has moved. If that term sheet implies a materially higher price than your last valuation, the old number is done, whether or not the financing ever funds. Founders who already promised option grants at the old, lower strike price are left holding an awkward gap: the number they quoted isn't defensible anymore, but the recipient was told it. There are ways to bridge that gap—a bonus tied to exercise, or a fresh grant priced correctly under the new number—but the cleanest fix is timing: don't lock in a strike price for anyone while a term sheet is actively on the table.
What happens if you skip it
Some very early companies grant options without a current 409A to save money. That's a real gamble: if the IRS later decides your strike price was too low, the affected employees—not the company—owe the back taxes and penalties. It also becomes a diligence flag for investors and acquirers, who will ask for your 409A history before closing.
Granting your first options?
Nebo Legal helps founders time their 409A, set up an option pool, and get board approvals in place before the first grant goes out.
Book a callFAQ
Do pre-revenue startups need a 409A?
Yes, if you're granting options. The valuation can be low for an early-stage company, but the safe harbor protection still requires a current report.
How long does a 409A take?
Typically one to two weeks once the valuation firm has your cap table and financials, though it can be faster for very early-stage companies.