What is a 409A valuation? Process, costs, and how to interpret it

If your startup offers equity, you'll need to budget for running a 409A valuation. This independent appraisal determines the fair market value (FMV) of your common stock, which in turn determines the strike price—the price employees pay to exercise their options.

It’s important to get an accurate valuation, as it affects both your employees’ returns as the company grows and the equity you can offer new hires.

In this guide, we explain what a 409A valuation is, when startups need one, and how it's determined. We also walk through the process of getting a valuation, typical costs, and tips for reading your report to ensure your strike prices are defensible.

What is a 409A valuation?

A 409A valuation is a formal process that determines the value of your company’s common stock. While the outcome sets the strike price for stock options, the process itself involves assessing your startup’s financials, industry outlook, and recent fundraising.

An independent third party must complete this valuation to comply with Internal Revenue Code (IRC) Section 409A. The IRS requires this appraisal to ensure you issue stock options at fair market value, which protects both your company and your employees from tax penalties.

It’s not just a one-time task; it’s a recurring expense that most startups will need to revisit annually or after a new funding round.

When do startups need a 409A valuation?

Startups typically need a 409A valuation before issuing stock options for the first time, especially if you’re hiring employees or bringing on advisors. Beyond the initial issuance, a valuation is valid for up to 12 months from the issue date of the final report, or until a material event occurs, whichever comes first.

If you plan to offer equity, a 409A valuation is generally required. Without one, you could undervalue stock options and expose your company and employees to significant tax penalties. To stay compliant and avoid unnecessary risk, most startups revisit their 409A valuation annually or after major business changes.

Material events that require a new 409A valuation

A material event is a business milestone that can significantly impact your startup’s fair market value. If one occurs, you’ll need to update your 409A valuation before issuing new options. Common examples include:

• Closing a new funding round
• Preparing for an initial public offering (IPO)
• Receiving an acquisition offer
• Major changes to annual revenue, profitability, or business strategy

Refreshing your valuation after these events ensures your strike price remains defensible with the IRS and protects employees from unexpected tax consequences.

What is the penalty for not providing a 409A valuation?

Non-compliance penalties can be severe if you need a 409A valuation and fail to obtain one. For example, if the IRS determines your stock options are at an undervalued strike price, it can impose a 20% tax penalty on deferred amounts, which can affect the company’s value.

Beyond direct tax consequences, skipping or underpricing a 409A valuation can trigger audits, back taxes, and reputational risk with investors. Non-compliance during due diligence may delay or even derail fundraising or acquisition opportunities.

How is a 409A valuation determined?

There are three main methodologies for calculating a 409A valuation:

• Market approach: Looks at comparable companies, industry trends, and recent fundraising to establish value. This often matters most in early stages, when your latest funding round heavily influences your valuation.
• Income approach: Uses forward-looking information such as financial projections, cash flow, and growth goals. These projections are the only part of the process under your control.
• Asset approach: Less common for startups, this approach values your company based on its tangible and intangible assets

In practice, the three biggest drivers of your 409A valuation include:

1. Investments: Your latest funding round and the price investors pay will often be a large driver, particularly before you have revenue. The higher your startup valuation, the higher your 409A valuation.
2. Industry: Fast-growth industries will lead to higher 409A valuations. Fintech, biotech, and AI demand higher valuations because companies in those industries currently have a high potential for future growth.
3. Projections: Since 409A valuations last for 12 months, your valuation firm will include forward-looking information such as your financial projections, cash flow, and goals for the business over the next 12 months. The better your projections, the greater your 409A valuation. Of these three, your projections are the only metric within your control.

The IRS requires independence, meaning a qualified third-party valuation provider must perform this process. Appraisers review your documentation, apply the valuation methods, and deliver a report valid for 12 months, or until a material event occurs.

409A valuation benchmarks by funding stage

Your startup’s FMV directly impacts its strike price and is highly dependent on your company's revenue, growth, and industry. Here are rough benchmarks we see based on hundreds of startup 409A valuations:

• Seed-stage funding: If you close simple agreements for future equity or convertible notes, your FMV will be 20–50% of your valuation. For example, if you raise on a valuation cap of $20 million, your company’s valuation can be as low as $4 million.
• Series A–B: Your FMV will be 50–80% of your pre-money valuation. If you raise on a pre-money valuation of $500 million, expect a valuation as low as $250 million.
• Series C and beyond: Later-stage 409A valuations are highly specific to the company at hand. Expect a lower discount than your earlier rounds. At this stage, your auditor should advise on expectations based on their understanding of your startup.

Similar to the consequences of not obtaining a 409A valuation, there can be severe tax penalties if the IRS determines your valuation is too low and does not accurately reflect your startup’s fair market value.

The IRS may treat all employee shares at an undervalued strike price as part of your employees’ gross income and can also impose a 20% penalty on stock options, in addition to back taxes.

How to get a 409A valuation for your startup

Here’s a step-by-step look at how to get a 409A valuation, from choosing a provider to preparing documents and finalizing your report.

1. Choose a 409A valuation provider

The first step in securing a 409A valuation for your startup is to choose a qualified, independent third-party provider. Evaluate audit firms using these three criteria:

• Track record: Ask firms if their valuation services stand up against the “Big Four” auditing firms (Deloitte, EY, KPMG, and PwC), the IRS, and the Securities and Exchange Commission (SEC). Consider valuation firms with good records of audit-proof valuations.
• Domain expertise: A reputable valuation firm has experience valuing your industry. For example, if you’re a high-growth startup, don't pick an auditor that values profitable small businesses. The valuation will take longer and is less likely to be accurate.
• Guarantee: Ensure your valuation firm offers all companies free lifetime audit review support at no additional cost

2. Prepare your documents

Most valuation firms ask for documentation to determine your company's FMV. Here’s what you need for a 409A valuation:

• Updated cap table: Inaccuracies on the cap table can affect and delay your valuation if not caught quickly enough
• Latest articles of incorporation: This document is sometimes called a charter or certificate of incorporation. If you raise an equity round, your lawyers will amend this document, so make sure you have the latest version on hand.
• Historical and projected financial statements: These can be your profit and loss (P&L) statement or balance sheet from your accountant or accounting software. You must provide financials for the past 3 years and projections for the next 12 months.
• Board presentation and recent pitch deck: This is optional but recommended. These materials give the valuation firm a better grasp of your business and value proposition.
• Number of options you plan to issue in the next 12 months: While not required, providing this information can help the valuation firm better understand how your cap table may evolve over the next year. Take your hiring plan and multiply the median number of options by the number of people you plan to hire.

3. Review and finalize your 409A valuation

Once you submit your documents and optional materials, the valuation firm will analyze your startup and provide a report that includes your FMV and strike price. To finalize this valuation, you’ll typically review the draft report to ensure all data is correct, flag any inaccuracies, and send it back to the valuation firm.

Once everything is up to par, the firm will send a final, signed report that is valid for 12 months, or until a new material event occurs. If your valuation provider offers lifetime audit support, keep their contact information handy in case auditors or the IRS challenge the valuation.

How much does a 409A valuation cost?

409A valuations typically cost between $1,000 and $1,500 for seed-stage companies and increase by $500 to $1,000 with each subsequent round. For later-stage or more complex businesses, valuations can reach $5,000 or more, depending on company size, financial complexity, and provider reputation.

Be wary of low-cost valuation firms. Some 409A valuation firms use automated statistical models to provide fast, low-cost reports, and this comes with two risks:

• High valuations: Low-cost providers often overprice shares by 30–50% to reduce compliance risk. The money you save up front may come out of your employees’ paychecks through higher strike prices.
• Deterring investors: IRC 409A compliance is part of the due diligence for every investor and acquirer. A missing or non-compliant report can delay or deter future investors.

Tips for reading your 409A valuation report

It’s a common misconception that your 409A valuation should always be a fixed percentage of your preferred stock price. While this may have been a simpler approach for early-stage companies in the past, it’s no longer a reliable method for determining your company’s FMV.

When reviewing your report, pay close attention to the strike price, the assumptions your appraiser used, and the valuation methodology—market, income, or asset approach. The ratio of common to preferred shares depends on several factors, including economic conditions during fundraising, valuation, the company's growth, and market trends.

There are cases where valuations are genuinely too high due to mistaken assumptions or flawed valuation methodology. Start by reading your report and consider the following:

• Company narrative and risk profile: Are they accurate? Are there long-term concerns that make your company riskier than portrayed?
• Comparable companies and competitors: Did the valuation firm use the right peers? If not, suggest better comparables that align with your business model and market.
• New information: Has anything changed since the valuation, such as a new competitor, product launch, or shift in the market, that the firm didn’t account for?

Treat your valuation firm as a partner in the 409A valuation process. Valuation firms often have a point at which they believe they cannot go lower. In other words, they can’t give a valuation that's too low to defend to the IRS.

Save on your 409A valuation with Ramp and Pulley

Ramp partners with Pulley to help you save on the cost of your 409A valuations. If you use the Ramp Business Credit Card or other products under our finance automation platform, you can get 25% off your first year with Pulley, including its 409A valuation services.

Pulley works with trusted experts in 409A valuations to get you a fast, fair, and accurate 409A valuation. Its partners have 100% audit-proof defensibility against the IRS and the Big Four firms, and Pulley provides a lifetime guarantee on all of its reports.

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The information provided in this article does not constitute legal or financial advice and is for general informational purposes only. Please contact an attorney or financial advisor to obtain advice with respect to the content of this article.