What is a 409A valuation and do I need one?
Takeaway: A 409A valuation is an independent appraisal of your common stock’s fair market value (FMV). It’s essential for setting the exercise price of stock options to avoid severe IRS tax penalties, but generally not required for issuing restricted stock at incorporation when the value is nominal.
A 409A valuation gets its name from Section 409A of the Internal Revenue Code, which imposes strict rules on deferred compensation—including stock options. If an option is granted with an exercise price below the stock’s FMV on the grant date, it can trigger harsh tax penalties for the recipient, including immediate income recognition, a 20% additional federal tax, and potential interest charges.
A 409A valuation, performed by a qualified, independent appraiser, creates a “safe harbor” that the IRS will accept as proof of FMV, shielding employees from those penalties.
When you must have one
Before granting stock options: You need a current 409A valuation in place before issuing any stock options. This is a hard requirement—there are no exceptions.
Updating regularly: Once you start granting options, you must update your 409A at least every 12 months, and sooner if you have a “material event” (e.g., a financing round, major revenue milestone, or significant acquisition offer).
The case of Restricted Stock Awards (RSAs)
RSAs are actual stock grants, not options. The tax rule is different: the recipient must purchase the shares at FMV or recognize the difference as income immediately.
At incorporation: Before your company has raised money or created value, the board can reasonably set FMV at a nominal price (e.g., $0.00001/share) without a formal 409A. This is why founders typically receive their stock right at formation.
After the company has value: Once you’ve raised capital or achieved milestones that give the stock real value, issuing RSAs without a defensible FMV (often via a 409A) risks triggering immediate taxable income for the recipient. Most companies switch to stock options at this stage.
Bottom line
Stock options → Always require a current 409A before grant.
Restricted stock → Can be issued without one at formation if FMV is truly nominal; otherwise, you need defensible valuation support.
A 409A valuation isn’t just a legal box to check—it’s a recurring part of running a compliant equity program and protecting your team from avoidable tax disasters.
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.