409a Valuation Rules and Guidelines
When a business owner or founder wishes to sell his company or wants to estimate what his company is worth, the business will go through a valuation process. A business valuation takes into consideration the worth of the company in shares, its current market value, and the potential to perform and grow in value in the future. A 409a valuation is the perfect way to analyze the market value of the current shares of your company. This article offers you the reasons why a 409a valuation is important for your company and guidelines and rules to consider before getting it done.
What is 409a Valuation?
It has now become a norm for companies to offer employee compensation by granting them equity options. Earlier, when 409a was not established by the Internal Revenue Service (IRS), it was difficult for startups to analyze the value of their company options. 409a was introduced in 2005 with the motive of allowing companies to derive the fair market value of their business. A third-party service provider usually sets the value for a company. Companies use these values to set the strike rate for the options offered to the employees. Such valuations apart from estimating the net worth of your company help you identify the aspects that can boost your company’s value in the future.
Why is a 409a valuation important?
409a valuations become essential when a company, especially a startup, needs a financing round from investors. The valuation form is a certification that allows the investors to trust in the company’s potential. In other cases, companies may wish to introduce options as rewards to their employees, advisors, or board members after a few years of service. A 409a valuation becomes important in such cases so that a careful financial review of the business is done before allocating these shares. Also, when there are possibilities of a merger or an acquisition, the company as well as the businesses involved in the association may require a 409a valuation to take the operation forward.
Note — It is important to remember this valuation report has a validity of 12 months and must be renewed regularly.
Things to Consider During a Valuation
To have a 409a valuation report in place, there are a few rules and guidelines you must follow. Failing to consider them, may result in several noncompliance implications that can negatively impact your company value.
Requirements — Securing all the information about the company such as the names of the CEO, auditors, contracts, competitor list, fundraising data, financial statements, debts, and even the latest cap table if it is not the first time, are the primary steps in the valuation process.
Frequency — The first valuation report of a company will be ready mostly before it raises funds in the first financial round. Companies still in their early stages have 12 months to renew their strike price from the one mentioned in their valuation report. After this, a regular updation of the valuation is required to keep up the standards. This is called the 409a Refresh.
Deadlines — If you have started issuing shares to your employees, you may soon be required to have a valuation. Between two 409a valuations, there must not be a time interval exceeding 12 months. Also, if your company has gone through a major change, an immediate valuation is required no matter when your last valuation was.
Penalties — In cases where your valuation method does not adhere to IRC, has been delayed, or failed to be done, your company becomes eligible to pay penalties. You can expect 20% additional taxes as a result. If your valuation is not approved or the report has errors, you may have to repeat the process from scratch.
Hire a professional valuation service — You may know everything about valuation and deal with market assessments daily. Even so, it is always recommended to have a third-party analysis of the company for your valuation. This way you can eliminate risks and greater liability from your business. Also, later stages require dealing with a more complex valuation process. Professional service firms can handle them with their expertise.
Tricks to avoid penalties — It is important to understand your deferred compensation plans concerning the current FMV (Fair Market Value), payment schedule, incremental pays, and deferral election. Ensure all the compliance requirements are met by reviewing NQDC (Nonqualified Deferred Compensation) plans in advance.
Summing up
The prime purpose of getting a 409a valuation done is to ensure safe audits are done and find the right investors. But the valuation report does more than that. Businesses can analyze and determine their worth and protect their employees from being taxed unnecessarily. All these can be done at an even increased and more accurate rate, with the assistance of Eqvista. To understand your company valuation better and perform an accurate 409a valuation, try the Eqvista app now!
