October 1, 2026 · 7 min read
What Is a 409A Valuation? Definition, How It Works and Examples
How a private company values its shares for employee stock options, why that value is lower than what investors paid, and when it has to be redone.
- Valuation
- Stock options
- Tax
The 409A valuation meaning is simple: it is an independent appraisal of what one share of a private company’s common stock is worth. The company needs it to grant stock options to employees. The IRS, the US tax agency, accepts an option only if the price employees pay for each share is at or above that value on the grant date. Otherwise, Section 409A penalties apply.
If you hold options or invest in private companies, the 409A is a different number from the price investors paid. It values common stock, which is paid after preferred stock in a sale and cannot be sold freely. So it usually comes in well below the last round’s price. For an employee, that gap is what makes an early option valuable. For an investor, it means a 409A says little about what the whole company is worth.
12 months
Maximum age of an independent appraisal used for an option grant
20%
Extra federal tax on the employee if a discounted option fails 409A, plus interest
180 days
If an IPO is expected within this window, the start-up safe harbor is unavailable
What Is a 409A Valuation Used For?
Section 409A of the Internal Revenue Code taxes deferred compensation, meaning pay you earn now and receive later, when it breaks the section’s rules. A stock option stays outside 409A only if its strike price, the price you pay per share, can never be below the stock’s fair market value on the grant date. A listed company has a market price for that. A private company has none, so it needs an appraisal. That appraisal is the 409A valuation, also called a 409A appraisal or a section 409A valuation.
The appraisal sets the 409A price. That is the value of one common share that the board uses as the minimum strike for new options until the next appraisal. For startups, this is routine: a new 409A analysis at least once a year and after every priced round. Companies often reuse the same report to account for stock-based pay under US GAAP, the US accounting rules. That is why firms call it a 409A and ASC 820 fair-value analysis, after the accounting standard on fair value. It is a tax valuation first, and the accounting use comes second.
Why Common Stock Is Appraised Below the Last Round’s Price
Investors in a priced round buy preferred stock. Preferred stock carries a liquidation preference: in a sale, preferred holders get their money back before common holders receive anything. It often comes with other rights that common stock lacks. So the price of a preferred share overstates what one common share is worth. The cap table, the company’s record of every share class and who holds it, shows how much preference sits ahead of common.
The appraiser first estimates the value of the company’s equity as a whole, often by working back from the last round’s price. Then the appraiser splits that value across the share classes, using a model that pays out the preferences first. What is left for common is cut by a discount for lack of marketability. The discount reflects that employees cannot sell private common stock freely. The regulation names such discounts as a factor a reasonable method considers.
The gap narrows as the company gets closer to a listing. The chance of an IPO, in which preferred stock converts to common, rises. The marketability discount shrinks too. Where private valuations come from places the 409A beside the other prices a private company carries: the round price, secondary sales between holders and tender offers.
What Is a Section 409A Valuation Required to Show?
The regulation requires “the reasonable application of a reasonable valuation method.” The factors include what the company owns, including intangible assets, and the present value of its future cash flows. They also include the value of comparable companies and recent sales of its stock between unrelated parties, known as arm’s-length transactions. Control premiums and marketability discounts count too. A method that ignores material information is not reasonable. Neither is a value more than 12 months old, or one set before a material event.
Three methods are presumed reasonable, and they are known as safe harbors. When a company uses one, the IRS can overturn the value only by showing it was “grossly unreasonable.” So almost every venture-backed company uses one.
The safe harbors and limits that decide whether a 409A price holds
As of October 2026 · Treas. Reg. §1.409A-1(b)(5); IRC §409A(a)(1)(B)
General Information, Not Tax Advice
The tax result of an option grant depends on the plan, the grant documents and your own position. That includes the alternative minimum tax on incentive stock options. Take your grant to a qualified adviser before you exercise.
409A Valuation Example: From a $40 Round to a $13.50 Strike
What is a 409A valuation report made of? Here is a simplified one. A company closes a Series C round at $40.00 per preferred share. Two months later, it orders a 409A for its common stock. The steps below follow what goes into the report.
Illustrative numbers for a hypothetical company, with no market benchmark implied. Real allocations use option-pricing or scenario models. The discount is the appraiser’s judgment for that company and date
Method per Treas. Reg. §1.409A-1(b)(5)(iv)(B), as of October 2026
An employee granted 10,000 options at $13.50 pays $135,000 to exercise them. If the company later lists at $40.00, the spread, the gap between the share price and the strike, is $265,000. Now suppose the board had set the strike at $10.00, below the appraised value. The options would be discounted and fall inside 409A. The spread would then be taxed as the options vested, with the 20% additional tax on top.
Six months later, the company might run a tender offer, an offer to buy shares from existing holders, at $35.00 for common stock. That is a recent arm’s-length sale the next 409A has to consider, and the 409A price will usually rise. Exercising options has its own tax consequences too. One of them is the alternative minimum tax, a parallel US tax calculation that can apply to incentive stock options.
Common Mistakes with 409A Valuations
- Granting on a stale reportA report older than 12 months, or one written before a new round, gives no presumption. Grants made on it carry the risk.
- Treating the 409A as the company’s valueIt prices common stock for tax purposes. The round price and what a secondary buyer will pay are separate numbers.
- Using the start-up method too lateWithin 180 days of an expected IPO, or 90 days of an expected sale, the illiquid start-up presumption is gone.
- Ignoring secondaries and tendersTrades in the company’s own stock are evidence the appraiser has to weigh. Leaving them out makes the method unreasonable.
- Reading an online 409A calculator as a valuationA calculator produces an estimate. The safe harbors require an appraisal, a formula or a written report by a qualified person.
A 409A sets a price for common stock on one date that the company can defend, and options are granted at it. Its job is to hold up if the IRS questions it. It says little about what the company is worth.
The Terms This Page Uses
- Fair market value
- For 409A, the value of a share on a date, set by a reasonable method. It is the floor for an option’s strike price.
- Common stock
- The class founders and employees hold, paid after preferred stock in an exit. A 409A values this class.
- Preferred stock
- The class investors buy in a priced round, with a liquidation preference and other rights common stock lacks.
- Liquidation preference
- The amount preferred holders receive in a sale before common holders receive anything, usually their investment back.
- Discount for lack of marketability
- A cut in value because a share cannot be sold freely. Most 409A reports apply it to private common stock.
- Strike price
- The price an option holder pays per share on exercise. To stay outside 409A, it must be at least fair market value on the grant date.
- Deferred compensation
- Pay earned in one year and paid in a later one. Section 409A sets the rules it has to follow.
- Safe harbor
- One of three valuation methods the regulation presumes reasonable. The IRS can overturn the result only if it is grossly unreasonable.
- Cap table
- The record of every share class, option and convertible, and the order in which each is paid.
- Alternative minimum tax
- A parallel US tax calculation that can tax the spread on incentive stock options at exercise.
What People Ask About 409A Valuations
It is the appraised value of one common share of a private company on a given date. The board uses it as the minimum strike price for employee options. That keeps the options from being taxed as deferred compensation.
It is another name for a 409A valuation. Under the safe harbors, it can come from an independent appraiser who meets the §401(a)(28)(C) standard. A company under 10 years old with no traded equity can instead rely on a written report by a qualified person, generally someone with five years’ relevant experience.
At least every 12 months while the company grants options. It is also redone after any material event, such as a new priced round. A value older than 12 months, or one set before a material event, is not reasonable under the regulation.
Investors bought preferred stock, which is paid first in an exit and carries other rights. The 409A values common stock after those preferences and after a discount for lack of marketability.
Typically the cap table and the terms of each share class, financial statements and forecasts, and the terms of recent rounds. The appraiser also needs any secondary sales or tender offers and details of material events. The appraiser weighs all of this against the factors the regulation lists.
No. A secondary trade prices one block of shares between a willing buyer and seller, often of preferred stock. A 409A is a tax appraisal of common stock. Secondary trades are only one input to it.
Where Every Rule on This Page Comes From
Every rule was last checked on October 1, 2026, against the statute and the Treasury regulation. The worked example is illustrative. A 409A is a US federal tax concept. Other jurisdictions have their own rules for pricing employee equity.
- 01Code of Federal Regulations (via Cornell LII)Current textTreas. Reg. §1.409A-1(b)(5) — options at fair market value, reasonable valuation method, the three presumptions, 12-month staleness, 90- and 180-day exclusions
- 02US Code (via Cornell LII)Current text26 U.S.C. §409A(a)(1) — income inclusion, 20% additional tax and interest when a plan fails
This page explains how a market works. It is not investment advice, not a recommendation of any security, strategy or company, and not an offer to sell or a solicitation to buy anything. Private companies may never list or be acquired, positions in them can be illiquid for years, and the entire amount invested can be lost. Figures are accurate as of the dates shown and change. Requirements for investor status, and the tax treatment of a private holding, differ by jurisdiction — the jurisdiction is named wherever this page discusses either. Prepared by the AXEVIL Capital research team. Tax rules described here are United States federal rules unless another jurisdiction is named; they change every year and depend on your own facts. Nothing here is tax advice — take your documents to a qualified adviser.
What closed on the private market in the past two weeks
The rounds that priced, the tender offers that opened and the listings that filed — with the structure of each deal and the date on every figure. Written by the team that reads the paperwork.
Where to go from here
TaxesWhat Is a 409A Specified Employee? Definition, How It Works, ExamplesA 409A specified employee is a key employee of a public company. Deferred pay due when they leave waits six months. Who qualifies and how the delay works.
Cap tables & term sheetsWhat Is a Cap Table? Definition, How It Works and ExamplesA cap table lists who owns what in a company: every share class, option and convertible, before and after each round. How to read one, with a worked example.
TaxesWhat Is the Alternative Minimum Tax (AMT)? How It Works and ExamplesThe alternative minimum tax is a second way to work out US income tax. Exercising incentive stock options can trigger it before you sell. Rules for 2026.