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1. When do I need to get a 409A valuation?
If you are a privately held company in the US that plans to issue stock options, shares or other equity incentives to employees you will generally need to have a 409A valuation completed before setting the issue or exercise price of these securities. A company that is less than 10 years old has the ability to do this without an external professional if they have sufficient knowledge. However in practice few companies do this and most prefer to rely on an outside valuation professional.
2. Besides for issuing stock options, are there other situations when a 409A valuation is needed?
A 409A valuation will generally be needed if you plan to provide any kind of equity incentive scheme to employees including stock options, employee shares, stock appreciation rights, phantom stock, and profits interests.
3. If I have a 409A valuation report already, when do I need to get a new one?
409A valuations are valid for a period of 12 months or until a “material” event such as financing round or significant change in the business occurs.
4. What is the purpose of a 409A valuation?
A company that issues options or shares to employees below Fair Market Value, i.e. at a bargain price, is subject penalties by the IRS and recipients to taxes on the difference as well as penalties. Fair Market Value is defined by the IRS and is calculated in a 409A valuation report.
5. How long does it take to get a 409A valuation?
The time required to prepare a 409A valuation report varies somewhat depending on how complex a company’s business, finances and capital structure are, but most of our valuation engagements are completed within a range of 2 to 4 weeks.
6. Are 409A valuations also used for accounting purposes?
409A valuations are often also used as a basis to determine the expense for the Company’s expense for options or shares issued as compensations, in accordance with AICPA guidelines.
7. Does a non-US company need a 409A valuation?
Non-US companies that have key staff in the US and wish to provide them with equity incentives are subject to the same rules as US companies and will therefore typically need to get a 409A valuation even though the securities are for a foreign company.
8. What valuation methods are used in a 409A valuation?
According to the IRS guidelines, a 409A valuation must consider asset based, market based and income based valuation methods. Asset based methods are rarely used since most early stage companies have small amounts of tangible assets, although there are exceptions. Market based methods include guideline public companies, comparable transactions, and previous financings. For companies that have raised equity capital from external investors, the latter method is the considered the best indication although the analysis of preferred stock investments may be complex. Income based methods include capitalized earnings and discounted cash flow, but for early stage companies with negative earnings for several years and uncertain future projections these methods may be difficult to apply. For companies in sectors with high levels of uncertainty, such as biotechnology, additional methods including risk-adjusted net present value, Monte Carlo simulation and real options may also applicable.
9. We forgot to get a 409A valuation done last year, can we do one now?
409A valuations can be done retroactively, although the farther back the date the more difficult it becomes to have adequate data and to determine what was “known or knowable” with respect to the company’s finances, its overall business, the economy etc. at the time.
10. Can we do a 409A valuation ourselves?
For a company in existence less than 10 years there is a “safe harbor” for determining Fair Market Value internally if management has the requisite knowledge.
11. What happens if we issue options and don’t get a 409A valuation?
The company is subject to penalties from the IRS and employees that received options or shares would be taxed on the difference between the price set by the company and Fair Market Value as well as be subject to penalties and interest. In addition, the lack of a 409A valuation may become an issue in due diligence processes for future capital raising or sale/merger discussions leading to additional costs and/or reduced negotiation leverage in such transactions.
12. How does a 409A valuation compare to other kinds of business valuations?
The 409A valuation report will calculate the value of a single common share or similar equity instrument which will typically have a lesser value than its strictly proportional value based on ownership percentage, due to discounts for lack of control and lack of marketability. While the 409A valuation report may also derive the 100% equity value of the company that is incidental and not always clear in a report. It is generally not appropriate to use a 409A valuation report when considering an M&A or financing transaction.
13. Can a 409A valuation be used for other purposes?
No, a 409A valuation report cannot be directly used for another purpose. However the process and report format are very similar for gifts of securities and therefore these valuation reports can be efficiently produced side by side if company founders or employees are gifting shares.
For a more detailed discussion about valuation issues for 409A valuations use this link. Read More →