409A’s are outside valuations performed to help startups determine the strike price of their employees’ options. Can a convertible note decrease the 409A valuation, thus lowering your employees’ option strike prices?
The reason why startups hire an outside firm to do a valuation is so that there’s an independent third party that provides that valuation. And if the IRS requests it, the founders and board can share the valuation report with IRS to show how the option pricing was reached. That way the management team, or the board, isn’t figuring out what the strike price is - instead, you’ve got an independent, 3rd party valuation study/report.
There are a few different ways that an outside valuation company will determine the company’s value - but in general, it comes out to a function of the last preferred investment round.
Here is where a convertible note COULD come into play - of course, you’ll want to hire an outside expert to make sure this would apply to your company. The value of any company includes the company’s assets, minus the company’s liabilities. And since a convertible note is a liability, it could possibly decrease the value of the company - thus lowering the option strike price.
Figure out from your valuation if this could work for your startup!