As a business owner, you may often have to deal with your company’s valuation for investment rounds, equity dilutions, etc.
One key valuation component is the 409A valuation, which is essential to a company's financial health and regulatory compliance but may seem complex.
Worry not! This detailed guide will help you gain all the knowledge you need.
You can also connect with expert valuators to discuss your unique needs. Exitwise helps you hire the best M&A professionals who understand your requirements and offer personalized solutions.
A 409A valuation is an unbiased, third-party assessment of the fair market value (FMV) of a private firm's common stock. The evaluation is guided and regulated by the Internal Revenue Service (IRS's) Internal Revenue Code, specifically, section 409A.
This valuation aims to establish the cost, often called the "strike price,” at which a person or organization can purchase equity in a non-publicly traded company.
You will legally need a 409A valuation if you own:
This valuation helps investors and stakeholders determine the correct value of preferred stock and may also increase or decrease the capital investment.
If your company is listed on the stock exchange or offers private stocks to employees, you will need a 409A valuation:
You must ensure your company adheres to these requirements and conducts valuations on time to avoid legal implications.
The requirements for a 409A valuation are established by the Internal Revenue Service (IRS) in the United States. Here are the essential ones:
If your company wants to enter an M&A transaction, a 409A valuation is essential before entering the deal. Both parties (acquirer and target company) must fulfill any 409A valuation obligations.
The company must comply with all relevant laws and regulations.
Under US tax law, companies must do a 409A valuation at least once every 12 months or in case of a 'material event' (merger, change of business methods, funding, etc.) that could affect the company's value.
An independent, third-party qualified appraiser should do the valuation. It ensures that the valuation is unbiased and adheres to professional standards.
Your company may be penalized if you fail to comply with these requirements.
A 409A valuation involves a multi-step process that includes the analysis of financial statements, risks, legal liabilities, and current capitalization. Understanding the calculations involved in a 409A valuation is crucial, and here's a simplified explanation of the process:
The first step in a 409A valuation is to estimate your company's total value, known as its "enterprise value." This is typically done using financial data such as revenue, growth rate, and profitability and market data such as the valuation of comparable companies.
Three methodologies are used for a 409A valuation: the Income approach, the Market approach, and the Asset approach.
Once the enterprise value is determined, it is allocated across the various classes of equity (common stock, preferred stock, etc.) to arrive at the FMV for the common stock.
The concluding step is to apply a discount to the FMV because the stock is not publicly traded. This "illiquidity discount" reflects that private company stock is less liquid (more stringent to sell) than publicly traded stocks on the stock exchange.
It's important to note that an independent, qualified appraiser must perform a 409A valuation to ensure accuracy and compliance with IRS regulations.
Absolutely. Here’s the Exitwise business valuation calculator, which offers accurate valuation based on comprehensive calculations.
However, calculators can only provide an estimate, so you should engage a professional third-party valuation service for an official 409A valuation.
For many business owners, 409A valuation may seem new and uncommon. Here's a comparison with other standard and relevant valuation methods to give you an idea.
Note: a 409A valuation can be essential in VC valuation estimates.
You can perform the post-money and 409A valuations simultaneously, but each will yield different values.
Look at some commonly asked questions about 409A valuation.
The cost of a 409A valuation varies depending on the size and complexity of your business and can range between $1,000 to $10,000+. Some companies also offer valuations on a monthly subscription basis.
A 409A valuation is valid for 12 months from the date of the issuance of the valuation report or until a material event occurs that could reasonably affect a company's stock price.
Your 409A valuation can take a few days to a few months, depending on your company’s needs and situation. Generally, if all the required items are available, it takes about two weeks to get to a final draft of the 409A valuation.
No, 409A valuations are not public, unlike valuations for publicly traded companies. Private companies use them internally to calculate the fair market value of their common stock issued to employees and other stakeholders.
Understanding 409A valuations is crucial if you’re planning to issue equity or options. While the process can be complex, a clear understanding of a 409A valuation can help you navigate this process more effectively.
Always consult with a professional to ensure accuracy and compliance since a 409A valuation can only be done by a third party.
Need help figuring out where to begin? Exitwise can help you find the right professionals for your 409A valuation and other M&A transactions. Connect with us today, and we will help you hire the best M&A team.
Let Exitwise introduce, hire and manage the best, industry specialized, investment bankers, M&A attorneys, tax accountants and other M&A advisors to help you maximize the sale of your business.
