What Is a 409A Valuation, and How Is My Strike Price Set?
A 409A valuation is an independent appraisal of your company's common stock required by the IRS, and it's what sets the strike price for your stock options.
A 409A valuation is a formal, independent appraisal of what your company’s common stock is actually worth, named after the section of the tax code that requires it. Companies need one before granting stock options because the IRS requires options to be priced at or above fair market value; price them too low, and the options can trigger immediate tax liability plus a 20% penalty for the people holding them. This post covers what the valuation actually measures, how often it changes, and why your strike price is almost always lower than what investors just paid for their shares.
Why does a 409A valuation exist?
It exists because the IRS requires companies to set stock option strike prices at fair market value, and a 409A valuation is how that value gets established and documented. If a company grants options below fair market value without a defensible valuation behind it, the options can be treated as deferred compensation under Section 409A of the tax code, triggering immediate income tax on the spread, an additional 20% federal penalty tax, and interest, all falling on the employee, not the company. Getting an independent valuation from a qualified appraiser creates a legal “safe harbor,” a presumption that the price is reasonable, which protects both the company and its option holders from that outcome.
Who performs a 409A valuation, and how?
An independent, qualified third-party appraiser performs the valuation, not the company itself, since the whole point is an outside, defensible opinion of value. Appraisers typically use methods like the option pricing model or the probability-weighted expected return method to allocate the company’s total value across its different classes of stock, then apply a discount for the fact that private company shares can’t easily be sold, arriving at a final per-share value for common stock.
How often is the valuation updated?
At least once every 12 months, or immediately after what’s called a “material event,” most commonly a new priced funding round, whichever comes first. A valuation is only valid for the shorter of those two triggers: even a fresh valuation from three months ago becomes unusable the moment a new funding round closes, since that round provides new, more current information about what the company is worth. Other material events that can trigger an early refresh include an acquisition offer, a major shift in the business, or a significant change in financial performance.
Why is my strike price lower than what investors just paid?
Because your strike price is based on the value of common stock, and investors in a funding round buy preferred stock, which comes with rights common stockholders don’t have, things like a liquidation preference (a guaranteed payout before common stockholders see anything in an exit) and anti-dilution protection. Those extra rights make preferred shares more valuable, so a 409A valuation typically prices common stock at some fraction of the preferred price, commonly somewhere between 10% and 40% at earlier stages, narrowing toward the preferred price as a company approaches an IPO or acquisition, where those preferred-only protections matter less. This gap is expected and required, not a sign of a mispriced valuation.
Does a new 409A valuation change the strike price of options I already have?
No. Your strike price is fixed at the value from the moment your specific grant was priced, and it never changes for options you already hold, even after several new valuations come and go. A higher (or lower) 409A valuation only affects the strike price of new grants issued after that valuation takes effect; it has no retroactive effect on options already on the books. This is a common point of confusion: an employee sometimes assumes a rising valuation means their existing strike price went up too, when in fact it means the opposite: their fixed, older strike price looks even better relative to the new fair market value.
Worked example
Say your company raises a Series B round at $20 a share for preferred stock. The board then commissions a new 409A valuation, which comes back at $5 a share for common stock, a 25% ratio, within the typical range for that stage. A new employee granted options the following week receives a $5 strike price. An existing employee who was granted options a year earlier at a $2 strike price (based on the prior, lower 409A) keeps that $2 strike price unchanged; they now hold options with a larger built-in spread than the new hire, purely because they were granted before the valuation increased.
FAQ
How often does my company need to get a new 409A valuation? At least every 12 months, or sooner if a material event happens first, most commonly a new funding round.
Why is my strike price lower than the price investors paid in the last round? Because investors buy preferred stock, which carries extra rights and protections common stock doesn’t have, making it more valuable per share. Common stock is typically valued at some fraction of the preferred price.
Does a new 409A valuation change my existing option’s strike price? No. Your strike price is locked in at the value in effect when your specific options were granted, and stays fixed regardless of later valuations.
What happens if a company grants options without a valid 409A valuation? The options can lose their safe harbor protection, potentially triggering immediate income tax on the spread plus a 20% federal penalty tax for the option holder.
Who performs a 409A valuation? An independent, qualified third-party appraisal firm, not the company’s own finance team, since the valuation needs to be defensible as an outside opinion of value.
What to do next
Your actual strike price and the company’s most recent 409A valuation are both on your grant paperwork and cap table records, not in general industry ranges like the ones described here. You can model your own numbers at movewealth.io.
MoveWealth is not a broker-dealer, investment adviser, or lender. This is educational content, not financial, tax, or legal advice. Consult a qualified professional about your specific situation.