Alternatives to a 409A Valuation
Disclaimer: This post discusses general legal issues, but it does not constitute legal advice in any respect. This post is not a substitute for legal advice and is intended to generate discussion of various issues. No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel. Cara Stone, LLP. and the author expressly disclaims all liability in respect of any actions taken or not taken based on any contents of this post. The views expressed herein are personal opinion.
A 409A valuation is a process that determines the fair market value of a company’s common stock. It is often used in the context of granting stock options or restricted stock units to employees, as the Internal Revenue Service (IRS) requires that these equity awards be issued at a price that is no less than the fair market value of the company’s stock. While a third party 409A valuation report is a common option, there are alternatives that a company can consider.
One alternative is to do an internal valuation report. This can be done by someone who has the necessary background knowledge and experience in doing similar types of evaluation reports. This option may be enough to get a presumption of fairness, meaning that the strike price (i.e. the price at which stock options can be exercised) is set at the fair market value of the company’s stock.
Another alternative is to use a good faith determination of the company’s value. If this option is chosen, it is advisable for the board to document the factors that went into the determination of the valuation on a reasonable basis. This documentation can include the lack of a market for the stock, comparable valuations of similarly situated startup companies, internal discounted cash flow base valuations, or other valuation models that are acceptable in the industry.
It is important to note that if the board does not use a third party valuation method or one of the presumptively valid valuation methods, the company would have the burden of winning against the IRS if the IRS ever challenges the 409A valuation on its stock price. This means that it would be harder to win a case if it ever comes up, so it is important for the board to carefully consider its options.
Disclaimer: This post discusses general legal issues, but it does not constitute legal advice in any respect. This post is not a substitute for legal advice and is intended to generate discussion of various issues. No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel. Cara Stone, LLP. and the author expressly disclaims all liability in respect of any actions taken or not taken based on any contents of this post. The views expressed herein are personal opinion.
A 409A valuation is a process that determines the fair market value of a company’s common stock. It is often used in the context of granting stock options or restricted stock units to employees, as the Internal Revenue Service (IRS) requires that these equity awards be issued at a price that is no less than the fair market value of the company’s stock. While a third party 409A valuation report is a common option, there are alternatives that a company can consider.
One alternative is to do an internal valuation report. This can be done by someone who has the necessary background knowledge and experience in doing similar types of evaluation reports. This option may be enough to get a presumption of fairness, meaning that the strike price (i.e. the price at which stock options can be exercised) is set at the fair market value of the company’s stock.
Another alternative is to use a good faith determination of the company’s value. If this option is chosen, it is advisable for the board to document the factors that went into the determination of the valuation on a reasonable basis. This documentation can include the lack of a market for the stock, comparable valuations of similarly situated startup companies, internal discounted cash flow base valuations, or other valuation models that are acceptable in the industry.
It is important to note that if the board does not use a third party valuation method or one of the presumptively valid valuation methods, the company would have the burden of winning against the IRS if the IRS ever challenges the 409A valuation on its stock price. This means that it would be harder to win a case if it ever comes up, so it is important for the board to carefully consider its options.
