How often should a company update its 409A valuation?

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The 409A valuation market is projected to be 194.87 billion by 2030. These services comply with the Internal Revenue Code’s (IRC) Section 409A to provide accurate valuation to private companies. 

This section mandates that the private companies that are planning to offer stocks to their employees must perform 409A valuations. Why? - there are two reasons: 409A valuation helps you one is to set your company’s strike price and other is to stay away from adverse tax implications.

You must also remember it’s not a one-time process. You must regularly update this value to stay on the right side of tax and company regulations. But when do you need your 409A valuation? How often do you have to update this? This article will cover all the details.

 

Why is a 409A Valuation important?

409A valuation is a process that helps you set the exercise price of your stock options by finding their Fair Market Value (FMV). If you want to make sure your firm is in compliance with all tax regulations and stays out of IRS audit sessions — which can lead to legal concerns, tax issues, and even interruptions in business operations — get a 409A value.

Stock options allow workers and consultants to purchase your company shares at a predetermined price (strike price or exercise price) at a future date. 

The 409A provides a valuation that can be useful in figuring out the appropriate strike price to prevent any tax penalties. You can gain safe harbor status that protects you from future audits by obtaining a 409A value from a recognized appraiser.

Quick note - The IRS generally considers 409A values with "safe harbor" status to be "reasonable" (with a few exceptions, of course). The status of "safe harbor" applies to 409A valuations carried out by independent or unaffiliated parties.

 

How Often Should You Update Your 409A Valuation?

“You must update your 409A Valuation once every 12 months if you’re issuing stock options to your employees. This frequency may increase if there’s a material event.”

Why? One year can trigger multiple events in a company. You could have a key board member exit, raise new funds that might influence your worth, or there could be a significant market change. 

If your company's stock value changes rapidly or significantly since the most recent 409A valuation, then the frequency of 409A refreshes will be proportional to those changes. 

What’s a 409A refresh?

If your company's stock's fair market value changes significantly from the initial estimate, you must amend your 409A report with a valuation refresh. If your startup is expanding quickly, you need to file a fresh 409A every year to make sure you and your employees are getting the proper tax treatment. 

Remember: Each 409A valuation report’s validity is a maximum of 12 months. During that period, stock option grants will be governed by the same tax treatment specified in the report.

 

When Should You Get Your 409A Valuation Done?

Apart from your first 409A valuations, other important events require your attention for an update. Here’s a look at when you must get your valuations done. 

- Granting stock options: This is the foremost reason why companies must update 409A valuations. Every time you grant your employees a fresh batch of options, it’s recommended to get this done. Thus, you guarantee that your strike price aligns with the FMV.

- When achieving (or missing) a milestone: A startup's value might rise in tandem with a notable decrease in risk, such as launching a new product or meeting another significant milestone. On the other hand, failing to meet a deadline or switching to a different business plan could reduce the startup's worth and necessitate a fresh valuation.

- Fresh funding: The most frequent event that starts a fresh 409A is a new funding round. Adding more institutional investors impacts the startup's stock value and necessitates a revaluation.   

- Approaching an IPO: The startup may need a fresh 409A valuation and particular valuation methods when considering an IPO. Factors that substantially affect the value of a company's common stock include fast development or expansion, mergers or acquisitions, changes in financials necessitating an updated valuation, and other similar events.

- After multiple investment rounds: As capitalization tables become more complicated or challenging to interpret, startups may choose to change their 409A valuation to simplify things.

 

What Happens When You Fail to Update Your 409A Valuation?

The IRS may impose fines for non-compliance, which may be high for stockholders and employees. If your company doesn’t update its 409A valuation as required by the IRC, it will lose the safe harbor status and can face the following penalties.

- Deferred compensation instantly becomes taxable.

- Accrued interest on the adjusted taxable sum

- A 20% extra tax on all deferred payments

 

How to Avoid These Penalties?

Avoiding the penalty imposed by IRS Form 409a for valuation requires you to:

- Submit a 409A once a year or whenever a "material event" occurs. When you annually submit 409A, the valuation is updated to reflect the stock of the company's current fair market value.

- Complete the 409A appraisal with the help of a third-party expert. An impartial appraiser or a trained internal resource impartially guarantees the valuation procedure.

- Adhere to compliance methodologies. The valuation must satisfy professional standards by following proper methodologies, such as the income, asset, or market approaches.

- Record the valuation procedure. You must keep detailed records of the valuation procedure, presumptions, and conclusions to support the value in an IRS audit.

- Consider all relevant information. The valuation must consider all relevant data about the company's worth - financial records, market circumstances, and possibilities.

 

Stay Compliant With 409A Valuation Updates!

A reliable 409A valuation can make a business more secure. It gives outside investors clear guidelines and guarantees they aren't overpaying for the company's equity. It’s a great way for entrepreneurs to ensure their shareholders get what they expect: fair value.

There are three things to look for in a 409a valuation provider: competitive prices, superior services, and compliant valuations. This will prevent you from paying too much for an appropriate appraisal or choosing a less expensive option that could result in IRS fines.

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