A 409A valuation is the formal fair market value assessment of a private company’s common stock, used to set legal strike prices on employee stock options.

How it works

After a financing round, preferred stock often prices higher than common because preferred carries liquidation preferences and other rights. A 409A provider—typically a qualified firm—applies discounts for lack of marketability and other factors to derive a common-stock price below the preferred round price. The board adopts that value; new option grants use it as the exercise price.

Companies refresh 409As after material events: new funding, major revenue shifts, acquisitions, or roughly every twelve months. Carta, Pulley, and specialized valuation shops produce the report; the board minutes record approval. The process is slower than updating a cap table but cheaper than fixing tax problems later.

Why it matters

• Founders: You cannot responsibly grant options without a current 409A. Promising “we’ll fix the price later” exposes hires to IRS risk.
• Operators: HR and finance need the approved strike price before offer letters go out. Mismatch between board approval and grant dates creates compliance gaps.
• Investors: Clean 409A history speeds diligence. Messy or stale valuations signal sloppy governance.

Common mistake

Using the last preferred round price as the option strike price. Common stock is almost never worth the same as preferred; skipping a proper 409A can trigger penalties for employees even when everyone acted in good faith.

Related ideas

Stock option grants, 83(b) election, fair market value, and board approval of equity compensation.