Choosing the Best Date for your 409A Valuation

A 409A valuation is an estimate of a private company’s common stock’s fair market value (FMV) made by an impartial third-party appraiser.

The Internal Revenue Service (IRS) requires a 409a valuation every year if you grant deferred payment to employees in the form of the company’s common stock shares. A business has to be appraised before being sold, distributing its assets, and reporting purposes regularly. While it may take several days or weeks to complete a 409a valuation, the valuation date is when the company’s worth (also known as the fair market value) is determined.

According to the IRS, a valuation date is necessary for the 409a valuation procedures. However, the valuation date is different from the delivery date of the 409a valuation report. So how do you determine the suitable 409a valuation date?

When is a valuation required?

Different situations can affect valuation dates differently. Here are some of the events which can demand a 409a valuation:

1. If your company plans to offer employees equity in the form of stock options.
2. The business is attempting to value the common shares of the business.
3. There’s a need to determine the strike price for the company’s stock shares.
4. There is a new funding round or multiple rounds since the last date of granting shares.
5. It’s been over 12 months since the business got the last 409a valuation, as the FMV could have changed.

When should you select a valuation date?

There is an obvious need to set a valuation date if you received the last valuation over 12 months ago. Why? Because of the following:

The maximum validity period for 409A appraisals is twelve months from the effective date or until a material event.

Additionally, to comply with Section 409a of the Internal Revenue Code, a 409a valuation must be performed if it is planned to provide workers ownership interests in the firm or stock options in the company. To comply with federal tax law and to determine the strike price for the shares and options, a 409a valuation is performed at this time.

Other criteria should be taken into account, and the choice should be addressed with the business’s legal counsel before being made. Here are some questions you should consider when setting a valuation date:

1. Will there be a material event that could demand a 409a valuation?

As mentioned earlier, your last 409a valuation is valid for 12 months or until there is a material event. A material event is any occurrence that can change the company’s financial structure. These can be (but are not limited to):

1. A change in a company’s tax or corporate structure through the change in its registration from for-profit to non-profit.
2. Sale, merger, or acquisition of the business.
3. As a result of capital raising activities such as the issuance of convertible securities or the sale of preferred or common stock.
4. Stocks held by the corporation have been sold off in large quantities.

If you anticipate any of the above events, you can set a date for a new 409a valuation.

2. When will the stock options be issued?

Companies often initiate a 409a valuation when they need to offer options to employees since the Internal Revenue Service classifies stock options as deferred compensation.

To avoid any tax complications in the future, these stock options should be provided at their true market value. If you plan to recruit new people soon and give them stock options, you can have a 409a valuation done and secure the share price for the entire 12 months when you award the options. Before proposing this valuation or utilizing it to establish option grants spanning historical periods, you should get legal counsel.

3. When will you close a new funding round?

If you plan on getting funds from venture capitalists (VCs), we suggest you set the valuation date right after a funding round because you’ll have everything you need to value the company by then. This approach simplifies the valuation procedure, which is a key advantage.

4. When did the most recent accounting period end?

Financial statements will be more reliable once the accounting period has ended. If your company uses a monthly accounting system, selecting the last day of that month as the valuation date should be simple. If financial statements are only closed once a quarter, the latest date of the quarter approached should be used as the valuation date. If the firm closes its books once a year, you’ll need to implement new accounting and financing tools to have access to more up-to-date and accurate financial data. Here, you get to decide on the last day of the session.

Now that you can determine an appropriate valuation date, you must work with an expert with experience in valuing businesses like yours. This is because we already know that an improper valuation can leave you with some severe IRS penalties. A valuation partner should have the qualifications and skills to do valuations to ensure 409A safe harbor and significant expertise in your industry, market, and development stage.

Entrust Eqvista for your next 409a valuations, as they are leading valuation providers with NACVA-certified experts. They can assist you in obtaining a thorough 409a valuation and ensure your businesses don’t face IRS penalties. Eqvista also offers tools for managing your cap table, issuing shares, and forming your company under all applicable legislation.