Do we need a 409A valuation even though we just had a financing with a set valuation?
Takeaway: Yes, absolutely. A financing round sets the price for your preferred stock, but a 409A valuation is the separate, formal appraisal required to determine the fair market value of your common stock, which will always be lower due to the inferior rights of the common shares.
This is one of the most common and logical points of confusion for founders. Your startup has just closed a Series A financing round where sophisticated venture capitalists bought stock at $5.00 per share. The value has been set by the market. So why do you now need to pay for an independent firm to perform another valuation?
The answer lies in the fundamental difference between the stock investors buy (Preferred Stock) and the stock your employees receive (Common Stock). A financing does not set the value of your common stock; it sets the price for a completely different class of security with superior rights. A 409A valuation is the legally required process for determining the specific, and lower, value of your common stock.
The Difference Between Preferred and Common Stock
Venture capitalists invest in Preferred Stock because it comes with a bundle of special economic and legal rights that make it more valuable than common stock. These include:
Liquidation Preference: This is the most important right. In a sale of the company, the preferred stockholders get their money back first, before the common stockholders receive a single dollar.
Anti-Dilution Protection: Preferred stock often comes with protection against future "down rounds," ensuring the investors' ownership percentage is not unfairly diluted.
Special Voting Rights (Protective Provisions): Preferred stockholders often have veto rights over major corporate actions, such as a sale of the company or a new financing.
Common stock, which is what founders and employees hold, has none of these special rights. It is last in line to receive proceeds in a sale and has fewer protections.
The "Discount" for Common Stock
Because it has inferior rights and is less liquid, common stock is inherently less valuable than preferred stock. The entire purpose of a post-financing 409A valuation is for an independent appraiser to analyze the specific rights of the preferred stock sold in the financing and to calculate an appropriate discount to determine the fair market value of the common stock.
In the early stages, this discount can be significant (e.g., the common stock may be valued at a 70-80% discount to the preferred stock). This discount shrinks as the company matures and gets closer to an IPO, at which point all preferred stock typically converts into common stock.
A Financing is a "Material Event"
Under the 409A regulations, a new financing round is a "material event" that immediately makes your old 409A valuation obsolete. You are legally required to obtain a new 409A valuation after the financing closes and before you grant any new stock options to employees. Granting options at the old, pre-financing exercise price would be a clear violation of Section 409A and would expose your employees to severe tax penalties.
A financing round provides a critical new data point that is a key input into your 409A valuation, but it does not replace it. The formal, independent appraisal remains the legal and procedural bedrock for safely setting the exercise price of your employee stock options.
Disclaimer: This post is for general informational purposes only and does not constitute legal, tax, or financial advice. Reading or relying on this content does not create an attorney–client relationship. Every startup’s situation is unique, and you should consult qualified legal or tax professionals before making decisions that may affect your business.