Why is it important for a business to know about 409a Valuation?

Are you ready to offer the equity of your company? Do you know what the shares of your company are worth? Have you done a valuation yet?

Well, before you go offering your company’s equity you must conduct a 409a valuation. Read further to understand the different aspects related to it. 

What is a 409a valuation?

The 409a valuation is an independent valuation of a company’s common stocks, to help determine what would be the cost of purchasing one share of the company.

This valuation is done at the fair market value (FMV). It’s a framework that all private companies need to follow while evaluating their private stocks. 

When is a 409a valuation considered to be a safe harbor?

When a company is through with its valuation, it can present the valuation report to the IRS. In case the IRS accepts the valuation, the company in question gets the status of a safe harbor.

However, in the situation of failure of compliance heavy penalties will be levied on the company. 

This valuation helps us come to a quantitative number of what the company is worth. To understand it in simple terms, it is a road map for companies to follow in terms of valuing their private stocks. 

When is a 409a valuation required?

If you want to sell a chair but you don’t know what that chair is worth you would not be able to sell it. Using the same analogy whenever a company wishes to offer equity, a 409a becomes extremely critical.

Without being aware of the value of a share it’s impossible to sell those shares.

How much does a 409a valuation cost?

The cost for a 409a valuation will depend on the firm or appraiser you have appointed for the task. However, going on a rough estimate the cost could lie anywhere around $1200 – $5000. 

What is the validity of a 409a valuation?

A 409a valuation is valid until 12 months or until a material event occurs, whichever happens first.

Material events here could refer to a new funding round, acquisition by another company, change in the business model, or other such events that bring a significant change in the company.

How to do a 409a valuation?

A company can follow any of the three routes mentioned here for its valuation. Startup Incubators can also be a very helpful resource to help companies with this valuation or get them in touch with the appropriate organizations.

• Do it on your own –

You can do the 409a valuation on your own. However, you must remember this option comes with its own sets of drawbacks. You will save on money but you will not be eligible for a safe harbor. 

• Use software to do it –

This option is just as risky as the previous one since the onus of proving the correctness of your valuation falls on you. There is a lot of scope for making mistakes. Go forward with this method only if you have expertise in the area.

• Get a firm to do it for you –

This is probably the most expensive option since you will have to pay the appraiser for the valuation but it’s also the safest option. Here you are under no burden to prove the correctness of your valuation.

However, you must ensure the independent firm or appraiser you choose is reputed and well qualified. This method will ensure you can get a 409a safe harbor.

There are different firms that you could approach for your valuation like Aranca, Preferred Return, and Andersen.

What are the documents required for a 409a valuation?

For a 409a valuation, there are certain documents and information that you require. These are,

• Article of Incorporation
• Cap Table 
• Previous 409a Valuation (if applicable)
• Your Industry 
• Income Statement 
• Balance Sheet 
• Cash Flow Statement 

It usually takes up to 3 weeks to complete the entire valuation. However, having the documents updated and ready ensures the valuation process gets completed far quickly.

You also have the option of fulfilling the process in a matter of days by paying a premium fee. 

What are the 409a penalties?

In a situation where the valuation isn’t done in a manner that complies with the 409a valuation regulation then, penalties are levied. Employees and shareholders are the ones who will have to bear the penalty.

An additional 20% of tax can be levied by the IRS on the deferred compensation and other severe actions are taken in case of non-compliance.

Conclusion

A successful start-up/business follows all the rules and regulations. Hence, it’s a must if you want to grow your business to conduct a 409a valuation keeping in mind all the key aspects that have been discussed above.

In addition, Alcor private equity and Venture capital firm also empower founders and businesses to grow their companies at all stages.

We are one of the largest capital venture firms, come grow with us!