--- title: "409A Valuation | Altss Glossary" description: "A 409A valuation is an appraisal of the fair market value of a private company's common stock, used in the US to set option exercise prices so the options…" canonical: "https://altss.com/glossary/409a-valuation" --- Glossary · Valuation # 409A Valuation A 409A valuation is an appraisal of the fair market value of a private company's common stock, used in the US to set option exercise prices so the options fall outside Internal Revenue Code section 409A. Publisher: Altss LLCContent modified 2026-10-02 ALTSS-VC-052 US startups grant employees options to buy common stock. If an option's exercise price is below the stock's fair market value on the grant date, the option can count as deferred compensation under the tax code, and if it does not otherwise comply the employee can be taxed before exercising it and owe an extra tax. Companies therefore commission an independent valuation of the common stock and set exercise prices at or above it. ### Formal definition Section 409A of the Internal Revenue Code governs nonqualified deferred compensation. Under Treasury Regulation 1.409A-1(b)(5), a stock option on service-recipient stock is not deferred compensation if, among other conditions, its exercise price can never be less than the fair market value of the underlying stock on the grant date. For stock that is not readily tradable on an established securities market, fair market value must be determined by the reasonable application of a reasonable valuation method (1.409A-1(b)(5)(iv)(B)(1)), and the regulation lists methods that are presumed reasonable (1.409A-1(b)(5)(iv)(B)(2)). ## Jurisdiction and status Section 409A is US federal tax law. The valuation rules cited here are in Treasury Regulation 1.409A-1 (current eCFR text, last amended in 2016). Other countries have their own rules for pricing employee options. ## Tax treatment (US) If an option is granted below fair market value and does not otherwise comply with section 409A, amounts deferred under it can become includible in the holder's income once they are no longer subject to a substantial risk of forfeiture (typically as the option vests) rather than on exercise, and the holder owes an additional tax equal to 20% of the amount included plus interest. The tax falls on the employee or other service provider, but the company has a strong practical interest in avoiding the outcome. A defensible valuation is the company's main protection. The statutory basis is section 409A(a)(1): when a nonqualified deferred compensation plan fails the section's requirements, deferred amounts become includible in income to the extent not subject to a substantial risk of forfeiture, and the tax is increased by an interest charge and by an amount equal to 20% of the compensation included. ## The presumptions of reasonableness The regulation presumes a valuation reasonable, so the Internal Revenue Service (IRS) can challenge it only by showing it was grossly unreasonable, in three cases: (1) an independent appraisal meeting the requirements of Internal Revenue Code section 401(a)(28)(C), as of a date no more than 12 months before the grant; (2) a value set by a formula that would count as fair market value under a permanent (nonlapse) transfer restriction, where the company values that class the same way for transfers to itself or to holders of more than 10% of the voting power and uses the method consistently; and (3) for illiquid stock of a startup, a valuation made reasonably and in good faith and evidenced by a written report, performed by a person the company reasonably determines is qualified on the basis of significant knowledge, experience, education or training, where no material trade or business of the company (or a predecessor) has been conducted for 10 years or more, the company has no class of equity traded on an established securities market, the stock is not subject to a put, call or other purchase right (other than a right of first refusal on a third-party offer or a lapse restriction), and no change in control within 90 days or public offering within 180 days is reasonably anticipated. Venture-backed companies commonly rely on the first, which is what the market calls "a 409A". ## Market practice Companies typically commission an independent appraisal at least every 12 months and again after any material event, such as a new financing, a significant change in results or a credible acquisition approach, because a valuation that no longer reflects all available information may not be relied on. Valuers usually estimate the company's equity value and allocate it across share classes with an option pricing method calibrated to the latest preferred round (a backsolve), a probability-weighted expected return method (PWERM) or a hybrid, and then apply a discount for lack of marketability to the common. Practitioners commonly follow the American Institute of Certified Public Accountants (AICPA) accounting and valuation guide on privately held company equity issued as compensation (2013 edition); the AICPA posted a working draft of a revised guide in January 2026, which is not yet final. ## Current value method The current value method (CVM) allocates equity value among the share classes as though the company were sold on the valuation date, applying each series' liquidation preference and conversion rights to that hypothetical sale. It gives no weight to how value might change before an actual exit, so when the preferences exceed current equity value the common stock receives nothing under it. The [IPEV Valuation Guidelines](https://altss.com/glossary/ipev-valuation-guidelines) list it with scenario-based methods (including PWERM), the option pricing method and the hybrid method as the four allocation methods commonly used in practice, and say it could be used when an exit transaction is imminent. Their criteria for choosing a method include reflecting the company's going-concern status and assigning some value to junior instruments unless the company is being liquidated. ## Why common is worth less than preferred Venture [preferred stock](https://altss.com/glossary/preferred-stock) carries a [liquidation preference](https://altss.com/glossary/liquidation-preference), protective rights and often seniority; common stock carries none and is usually less marketable. In outcomes below the preference stack, common receives little or nothing. A 409A value of common below the latest preferred price is therefore expected, and the gap narrows as an IPO becomes likely and preferences matter less. ## 409A values and fund valuations A 409A valuation measures the fair market value of common stock for tax purposes. A venture fund's holding is usually preferred stock, reported at [fair value](https://altss.com/glossary/fair-value) for financial reporting: the exit price defined in Accounting Standards Codification (ASC) 820-10-35-2 in the US, or its International Financial Reporting Standard (IFRS) 13 counterpart elsewhere, often estimated following the IPEV Guidelines. The methods overlap, but the unit of account and purpose differ, so a fund does not mark its preferred position to the company's 409A value, and the 409A value is not a fair value of the company. ## Not the same as - [Fair Value](https://altss.com/glossary/fair-value): Fair value under ASC 820 / IFRS 13 is a financial reporting exit price for a specific asset; a 409A valuation is a tax fair market value of common stock for option pricing. - Price of Recent Investment: The latest preferred round price reflects preferred rights; using it as the common stock value would overstate the strike price, and using it as a fund mark ignores class differences. ## Common mistakes - Using the latest preferred price as the option exercise price, or assuming the common is worth the same. - Relying on a valuation older than 12 months, or one made before a material event such as a new term sheet. - Assuming the penalty falls only on the company. The additional tax falls on the option holder. - Treating the 409A value as the company's valuation or as a fund's mark. ## Edge cases - Grants made between signing a term sheet and closing a round are a common risk: the existing 409A may no longer reflect available information. - Secondary sales of common at prices above the 409A value can be evidence the valuation needs to be revisited, depending on their size and terms. ## Questions ### How often does a company need a 409A valuation? The independent-appraisal presumption covers a valuation as of a date no more than 12 months before the grant, and only if nothing material has changed since. Companies refresh at least annually and after financings or other material events. ### What happens if options are granted below fair market value? If the options do not otherwise comply with section 409A, amounts deferred under them can become taxable once they are no longer subject to a substantial risk of forfeiture (typically as they vest), and holders owe an additional tax of 20% of the amount included plus interest. ### Is a 409A valuation the same as the company's valuation? No. It values the common stock, which has fewer rights than the preferred stock investors buy, for tax purposes. ## Sources - [26 CFR 1.409A-1 - Definitions and covered plans (incl. 1.409A-1(b)(5)(iv)(B) stock valuation)](https://www.law.cornell.edu/cfr/text/26/1.409A-1). Internal Revenue Service / U.S. Department of the Treasury (CFR text via eCFR; LII mirror), eCFR current as of 2026-09-29; last amended 2016-05-18. Status: in force (checked 2026-10-01). 26 CFR 1.409A-1(b)(5)(i)(A)(1), (b)(5)(iv)(B)(1), (b)(5)(iv)(B)(2)(i)-(iii) (eCFR last amended 2016-05-18) — supports: Stock right exclusion conditioned on exercise price never below FMV at grant; reasonable valuation method and 12-month / later-information limits; the three presumptions of reasonableness and their conditions; rebuttal only on a showing of gross unreasonableness - [Valuation of Privately-Held-Company Equity Securities Issued as Compensation - Accounting and Valuation Guide](https://www.aicpa-cima.com/cpe-learning/publication/valuation-of-privately-held-company-equity-securities-issued-as-compensation-accounting-and-valuation-guide-OPL). AICPA (AICPA & CIMA), 2013 edition (AICPA resource page dated 2013-12-22); under revision. Status: under revision (checked 2026-10-01). AICPA resource page dated 2013-12-22 (scope of the 2013 edition) — supports: Practitioner guidance on valuing private-company equity issued as compensation - [Working Draft of the Updated Valuation of Privately-Held-Company Equity Securities Issued as Compensation Accounting and Valuation Guide](https://www.aicpa-cima.com/advocacy/download/working-draft-of-the-updated-valuation-of-privately-held-company-equity-unpublished). AICPA (AICPA & CIMA), Page dated 2026-01-16; draft file dated 2025-12-18. Status: draft (checked 2026-10-01). AICPA download page dated 2026-01-16 (working draft file dated 2025-12-18) — supports: Revision of the AICPA guide in progress; not final - [ASU 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs](https://storage.fasb.org/ASU2011-04.pdf). Financial Accounting Standards Board, May 2011. Status: in force (codified in ASC 820) (checked 2026-10-01). ASC 820-10-35-2 (as amended by ASU 2011-04) — supports: Financial reporting definition of fair value (exit price in an orderly transaction between market participants at the measurement date) - [International Private Equity and Venture Capital Valuation Guidelines (2025 edition)](https://www.privateequityvaluation.com/Portals/0/Documents/Guidelines/2025%20IPEV%20Valuation%20Guidelines.pdf). IPEV Board, IPEV, Published 11 December 2025; in effect for quarterly reporting periods beginning on or after 1 April 2026; early adoption encouraged. Status: Current; supersedes the December 2022 edition (checked 2026-10-01). Fair value definition; Sec. I 3.10 Calibrating to the Price of a Recent Investment, incl. Complex Capital Structures, pp. 38–41 — supports: Fund valuation of venture holdings follows fair value guidance, distinct from tax FMV of common; equity allocation methods (scenario-based/PWERM, OPM, hybrid) and the current value method for an imminent exit, with the method-selection criteria (p. 41) - [26 U.S.C. 409A - Inclusion in gross income of deferred compensation under nonqualified deferred compensation plans](https://www.law.cornell.edu/uscode/text/26/409A). U.S. Congress (US Code via LII), Current US Code text as published by LII (accessed 2026-10-01). Status: in force (checked 2026-10-01). Sec. 409A(a)(1)(A)(i), (B)(i)-(ii) — supports: Income inclusion to the extent not subject to a substantial risk of forfeiture; interest at the underpayment rate plus 1 point and additional 20% tax ## Related terms 3 terms - [Employee Option Pool](https://altss.com/glossary/option-pool) - [Preferred Stock (Venture Convertible Preferred)](https://altss.com/glossary/preferred-stock) - [Fair Value](https://altss.com/glossary/fair-value) ## Concept record Concept ID ALTSS-VC-052 Classification Valuation · Legal, regulatory & tax Topics Venture capital & startups · Valuation Jurisdiction US Version 2.0.0 Last reviewed 2026-10-02 Structured data [JSON](https://altss.com/reference/concepts/409a-valuation.json) Source check Tax statements checked against the cited primary sources on 2026-10-02 ([how](https://altss.com/methodology)). General information, not advice. ## Canonical URL https://altss.com/glossary/409a-valuation