Hackernoon logoWhat is a 409a Valuation and How Do You Get One? by@eqvista

What is a 409a Valuation and How Do You Get One?

409A valuations are something every company has to get as soon as they step into the business world and begin issuing shares or stock options. When a company reaches the stage where they need to get their 409A valuation done, they then begin to look for the right 409A. 409A is a set of rules and regulations that private companies have to follow for valuing their common stock. This value under a 409a valuation is presumed to be ‘reasonable’ by the IRS and burden of proof falls on the IRS in case they decide to investigate.
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Eqvista

Equity Management Software

409A valuations are something every company has to get as soon as they step into the business world and begin issuing shares or stock options. And when a company reaches the stage where they need to get their 409A valuation done, they then begin to look for the right 409A valuation providers. Out of the rush and many available options in the market, it just becomes tough for a lot of companies to choose the one that would be the best. That is why this article was prepared to help you in choosing the right and top 409A valuation providers.

Before we move ahead, let us understand a little about what 409A valuations are and why a 409A valuation report is so important for your business. Read on!

What is a 409a Valuation?

409A valuations and compliance are not the most exciting parts of being a founder. But as far as dealing with your company equity and the taxes involved, they are very crucial for the long-term success of any company. So, what exactly is a 409A valuation? 

In 2001, the Enron scandal happened, where executives found loopholes to take advantage of their equity ownership. In response to the fallout of this scandal, government regulators were dedicated to finding a way to not allow this to happen again. That is where the IRS introduced Section 409A to the IRC (Internal Revenue Code).

The 409A basically is a set of rules and regulations that private companies have to follow for valuing their common stock. In short, the company has to get a third-party certified valuator to value their private stock and to establish safe harbor status.

This value under a 409a valuation is presumed to be “reasonable” by the IRS and burden of proof falls on the IRS in case they decide to investigate. In addition to this, 409A valuation providers have to follow the methods set by the IRS to get the final value of the company they are valuing.

When does a company require a 409a valuation?

If you have been in the business world for a while and already know about 409A valuations, then it is important for you to keep getting a valuation every 12 months. This is because 409A valuations are valid for only a year from when they are prepared. Another time when you would need this is when there is a “material event” in your company. This means that when there is a transaction that affects the stock price of the company. It can include funding round - issuing convertible debt to independent, institutional investors at a negotiated price, preferred equity, or the sale of the common shares.

In case you are not sure which event is considered as a material event, you can take help from a professional 409a valuation firm. Furthermore, you also need the 409A valuation when you are about to give out stock options to your employees.

So to put it simply, you will need a 409A valuation report:

  • Before issuing any of the common stock in your company
  • Before issuing stock options to your employees
  • Once every 12 months
  • After a material event
  • After raising a round of funding
  • If you are closing up on a merger, acquisition, or IPO

How to get a 409a valuation?

It is actually quite simple to get the 409A valuation report. All you need to do is follow the rules set by the IRS. And one of the main rules is to get a third-party appraiser to get it done. Other than doing the valuation by yourself, there are two other options for you to get a 409A valuation report:

Use valuation software 

There are many valuation calculators online. They can help you get a rough estimate value of your company. But this value does not have safe harbor status, as its often filled in by the company themselves, and not idependenlty reviewed. Therefore any value could be challenged by the IRS and the founders need to provide proof to show how they calculated the fair market value of the firm.

Hire a professional valuation firm 

The second option is the one where you undergo a 409a valuation by an independent appraiser. This method comes with a cost (usually ranging from $1,000 to $5,000), but the company will get safe harbor status, which is very important for any 409A valuation. This also means that it relieves you from the burden of proof from the IRS. But for this to happen, you need to find a certified, knowledgeable and experienced independent 409A valuation provider to help you. 

409a Valuation Providers

As shared above as well, there are a lot of 409A valuation providers available in the market. But which ones make the right option for you and your company can be confusing.

Top qualities of a 409a valuation provider 

You want to select a provider who has experience valuing companies that look a lot like yours. A valuation provider should have not only the right credentials and expertise conducting valuations to ensure 409A safe harbor, but also extensive experience in your sector, industry, and stage.

For instance, don’t engage a valuation provider whose clients are primarily companies that are slow-growing, brick-and-mortar businesses, if you’re a high-growth SaaS company. Think of it like picking an accountant: You would choose an accountant who is not just certified as a CPA, but also has extensive experience filing taxes for companies like you.

You also want to select a 409a valuation provider that has enough information online so you know what valuation your getting. A lot of valuation firms apply a simple plug + chug method: ie. they do a simple forecast of your future earnings X a multiple, and spit out a value. You should look for a firm that understands your company more, asks more in-depth questions, and seeks to use all the valuation methods that could apply. This will always give you a more accurate valuation of your firm.

Top 409a valuation providers 

  • Eqvista
  • Kruze Consulting
  • Meld Valuation
  • Scalar Analytics
  • Shareworks Valuation Services
  • Big Accounting Firms (Deloitte, EY, PWC, KPMG)
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Note: Data is based on information from sources online about each company.

Bottom line

With this, you now have a list of the top 409A valuation providers you can choose from. So when you are reading to issue stock or give out stock options in your company, ensure that you get a 409A valuation performed by the right firm.

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