A 409A valuation is a crucial tool for privately held companies issuing stock as part of their compensation packages. A qualified independent appraiser conducts the process to determine the company’s fair market value of its common stock. Understanding how it works is essential for founders or investors looking to set the stage for long-term growth. This article explores how often you get 409A valuation and potential triggers.
Table of Contents
1. The General Rule: After Every 12 Months
The Internal Revenue Service (IRS) mandates that private companies conduct 409A valuation for their standard stock options every 12 months. The valuation remains valid as long as no material event needing a new appraisal occurs. The process allows your business to use equity compensation to attract top talent and narrow the compensation gap between it and its competitors. It also enables you to qualify for a safe harbor provision. This means your valuation is considered valid and defensible by the IRS.
The Section 409A of the Internal Revenue Code (IRC) provides everything to know about 409A valuations. This includes compliance requirements that businesses seeking to complete the valuations must adhere to. For instance, companies must use independent specialists to complete the process. The appraiser must consider all available information affecting your company’s market value. Following these standards enables the valuation to remain valid for the next 12 months unless a reasonable material event occurs.
2. Materials That Can Trigger a New Valuation
Before the 12-month window expires, material events can significantly affect your company’s fair market value. These events force you to seek a new 409A to remain compliant and protect your stakeholders. For instance, a new round of funding often reflects investors’ perception of growth, risk, and valuation. This growth must be updated with a new 409A. Major milestones like launching a new product or signing a contract may also trigger a new market estimation.
You will need a new appraisal if your company is acquired or merges with another. These developments influence market perception and stakeholder value, attracting new tax and compliance requirements. When existing stakeholders sell common shares on the secondary market, it can signal a market change that requires a valuation update. Consulting an expert is crucial if you are unsure whether an event qualifies as material. This prevents the risks of legal implications and unfair market perception.
3. Best Practices for Scheduling A 409A Valuation
Scheduling the first 409A valuation seems straightforward, particularly if you have existing common stocks and shareholders. However, maintaining a clean market record and compliance requires regular updates and an understanding of changing triggers. To avoid surprises, treat your valuation like an annual audit. This means you should schedule it at the same time each year, ideally after closing your books or raising funding. This ensures it reflects the most accurate financial data.
Hiring a reputable independent appraiser ensures your documentation is thorough enough to defend you during an audit. You should also plan your valuation update before issuing grants or hiring new executives. This creates fairness and legality in your equity pricing. Safely storing all your 409A reports, cap tables, and board consents is recommended. Maintaining a clear internal calendar and communicating upcoming valuation events to legal and HR teams prevents compliance gaps.
Endnote
Getting a 409A valuation every 12 months is the general requirement for private companies issuing stock options. However, it is wise to be active in reassessing your market value whenever your company experiences a significant change. Understanding these timings and triggers for a new appraisal enables you to stay compliant with law and protect your business from tax exposure.
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