What Every US Founder Needs to Know About 409A Valuations

What Every US Founder Needs to Know About 409A Valuations

What Every US Founder Needs to Know About 409A Valuations
10-Oct-2017 by Nathan Parcells

As a founder, you aren’t spending your time thinking or learning about 409A valuations. But it is important to know the basics to help you choose the right provider and understand its impact on your company later down the road. This guide breaks down the difficulties of 409As into simple parts to ease the lives of founders.

What Every Founder Needs to Know About 409A Valuations

 

First a definition

A 409A is used to determine the fair market value (FMV) of your company and is set by a 3rd party valuation service. A 409A is required by the IRS in order to set the strike price for common shares and ensure that options represent their real value.

Differences

You first might be wondering about the difference between a 409A valuation and an investor valuation (the negotiated pre or post-money value). There are a few distinct features that make them different.

Primarily, when investors purchase a share they are getting preferred stock, rather than common stock; preferred stock has a higher worth because it guarantees liquidation preferences.

Secondly, investor valuations are decided by the market, where the valuation can be artificially raised by competition between investors. If your company is popular with investors your investor valuation will be higher than your Fair Market Value from your 409A.

Lastly, investors are professional risk takers. They are willing to overpay for a few moonshot startups by balancing them out by more conservative bets.

Independence

Once your 409A valuation is complete, it’s time for an audit. To comply with the IRS definition of independence, a 409A valuation may not be audited by the same firm who completed the valuation.  A third party audit firm, like the Big Four — Deloitte, PWC, Ernst & Young, and KPMG —  must complete the audit. There is a great deal of misinformation about what qualifies as independence leading to confusion for founders. The guidelines on independence were created to limit the scope of accounting firms, rather than the third party performing the valuation.

An easy technique to ensure that you choose a good provider for your company is to address any issues, doubts, questions you may have about the safety of your confidential material. A quality provider will be able to quickly answer your questions about the matter of client data and strategy for 409A valuations.

Changes

The price of 409A valuation service used to be extremely high, between $5,000 and $15,000, a huge burden to small startups. But thanks to new providers utilizing software, the price has dropped significantly. Companies like eShares are separating out their 409A services from all other departments, allowing for complete control of the product and ensuring complete confidentiality.

409As are extremely vital for a growing company’s health. Most obviously that it is required by the IRS and legally your company will not survive without it. But more importantly, it is valuable in understanding your value compared to the market. In the past, completing a 409A was simply a task to complete for the IRS, but with new technology, the report should be seen as a valuable tool for founders.

 eShares has developed a cap table platform which creates accurate and secure data for our clients. You can download our Cap Table template here. This model allows running efficient and secure valuations.

Conclusion

The most critical point in running a company is passing the audit. Without it, your startup won’t be able to progress further and all of your efforts as a founder will have been foiled. The first step to getting there is to be organized and understand what needs to get done and how you can achieve each of your goals.

With several valuation providers in the market, figuring out which one best aligns with your company’s goals can be difficult.  eShares gives you the best value for your money as both a valuation provider and cap table management software platform. eShares simplifies all repetitive tasks by building a fully equipped program. Try it out for yourself and check out a few of our free online resources here.

 

eShares is the leading 409A valuation provider and cap table software distributor because they understand that customers’ safety is key and always comes first. Building a separate 409A valuation division within the company is just one way that eShares combats valuation fraud and ensures total customer data protection.

Nathan Parcells is a former founder and current Digital Marketing Lead at eShares. Prior to joining eShares, Nathan started Looksharp, a Series-B backed tech company for students to find their next job. Looksharp raised over $10 million and grew to over 35 employees -- they managed all their equity and fundraises on eShares. At eShares Nathan helps early-stage companies and founders learn about equity best practices.