What Investors Expect: 409A + Stock Treatment
This is the final installment of our What Investors Expect series; I hope that the content we’ve provided has helped you to better interact with your new investors, and has set you on the path to success.
Firstly, what is a 409A valuation?
- A 409A valuation is an official report valuing the common stock of your company
Why do I need a 409 valuation?
- You need a 409A because the common stock you and your employees hold doesn’t have the same value as the Preferred shares your investors own
When do I need a 409A valuation?
- When your company first raises capital or when there is a “material change” in the business (new financing)
- When your business first issues stock options
- If it has been longer than 12 months since the last 409A valuation
How does the valuation process work?
- The valuation has to be done by a qualified individual, and you should hire an outside appraiser to avoid any problems with the IRS
- There are a few things to note which could impact the value of your common shares:
- Preferred stock features such as participation rights and dividends will affect the value of your common shares, with more investor-friendly features driving down the value of common stock
- Sale and transfer restrictions on common shares will also decrease their value, as there are fewer options for liquidity and lower odds of receiving an eventual payout
- Secondary market transactions, in which shares have traded in the secondary markets (ie a founder sells a block of shares separate from a fundraise), will affect how appraisers determine value
What happens if I don’t get a 409A valuation?
- Your employees will be subject to back taxes and a 20% penalty on any gains (applied annually)