One question we often get from startup founders is “what is the difference between a startup’s 409A valuation and its post- money valuation?”
We also get this a lot from startup employees with stock options who are trying to understand if the strike price on their newly issued options actually has anything to do with the company’s latest venture round.
The Purpose of a 409A Valuation
First, let’s look at the purpose of a 409A valuation and what a post-money valuation is:
- A 409A valuation sets the fair market value of your startup’s common stock, and this is done to set the option strike price for shares that are granted to employees.
- The post money valuation takes all of the outstanding shares in a startup and multiplies them by the stock price that the VC paid to purchase shares in the most recent venture capital round.
For example, let’s say a startup raises a series B, they’ve got 10 million shares outstanding, and a VC invested at $10 per share. This would mean the company’s post-money valuation is $10 times 10 million shares, or $100 million dollars.
How is the Post-money Valuation Different?
The 409A is probably going to be about 33% of the post-money valuation. Unlike a post-money valuation, the 409A valuation considers the different rights and privileges that the preferred shares, which VCs purchase, have. These rights and privileges are seen as more valuable than the common shares – which are given to the employees in the form of stock options. This is because preferred stock typically comes with liquidation preferences and other rights that common stock doesn’t have. Those rights make preferred stock more valuable.
The 409A Valuation Will Be Lower Than Post Money Valuation
Effectively, a 409A valuation will be less than a company’s post-money valuation. This is the bottom line when comparing the two:
- The post-money valuation estimates the startup’s work based on the value of all the shares being worth the same amount, which is then calculated based on the purchase price that a VC paid for those preferred shares. This essentially makes it a funding metric.
- On the other hand, a 409A valuation is generally produced by an accredited evaluation firm whose job it is to use a variety of valuation metrics to calculate the value of the common shares.
Use an Accredited Firm to Produce Your Valuation
We definitely recommend that you use an accredited valuation firm to produce your 409A because you want it to be defensible in front of the IRS. You don’t want any of your employees getting in trouble for not paying taxes that the IRS may decide they’re owed if the value of their options was different than the value of the strike price.
You really have to get the 409A done correctly, but in a strategic manner. In reality, you actually want the valuation to be a little bit lower than expected, as that makes your stock options more attractive to the employees. The option’s strike price is the dollar amount that an employee has to pay to exercise their options. So a lower strike price means that new employees, who you’re bringing on board, will get to pay less money to exercise their shares.
Strike Prices and Valuations
If your company is acquired, the employees actually have to put money in to be able to purchase those options and get their equity paid out. Therefore a lower valuation, from their perspective, would be better.
If you want to find out approximately how the 409A valuation compares to a recent post money valuation, the strike price and the common stock value on a 409A valuation is generally 25% -35% of the price that the VCs paid to buy their very attractive preferred stock. Therefore, if the VCs are paying $10 a share for their preferred stock, the strike price produced by the 409A valuation is likely to be $2.50 to $3.50.
These are just rough numbers, however, and every company is unique. That’s why our biggest piece of advice to you on this topic is to ensure you hire an accredited firm to produce that 409A valuation for you.
If you have any other questions on 409A valuations, startup financials, startup accounting, or taxes, please contact us. You can also follow our YouTube channel and our blog for information about accounting, finance, HR, and taxes for startups!
In Summary: 409A vs Post-Money Valuation
A post-money valuation and a 409A are both ways to determine what a company is worth, but for different purposes:
- Post-money valuation: A startup’s value after it receives outside investment or financing. It is calculated by taking the pre-money valuation and adding the capital raised. This is how investors determine their ownership stake in the company. Higher post-money valuations are considered a point of pride in Silicon Valley. However, too high of a post-money valuation can make it difficult to raise a subsequent rounds if the company can’t grow in it.
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409A Valuation: Determines the fair market value (FMV) of common stock for tax purposes related to stock-based compensation. It is a regulatory requirement from the IRS under Section 409A of the IRC, and should be conducted by a licensed provider. A 409A valuation is required when a company:
- After a company raises new capital, or
- Every 12 months.