A 409A valuation is a requirement from the Internal Revenue Code (IRS), identified as Section 409A. A 409A valuation provides a company with a report that states a suggested value for the company’s common stock. The purpose of finding this value is for the company to issue deferred compensation to employees at fair market value, which includes issuing stock options with an exercise price at fair market value. Newer companies that issue deferred compensation often have complex equity structures with varying classes of stock. Often, complex methods are required to value common stock in the context of diverse capitalization.
Any company that wishes to issue deferred compensation to employees needs a 409A valuation. Deferred compensation that is not issued at fair market value can incur significant consequences, including a 20 percent federal income tax penalty and varying state tax penalties. A 409A valuation helps protect your employees from future tax problems with the IRS. The fair market value must also be calculated by applying a suitable valuation methodology. A new 409A valuation must be performed if any of the following trigger events occur.
- Issuing employee stock options for the first time
- Raising a round of funding
- Any “material event” that alters the company’s value, such as loss of a major customer, an unexpected win of a new customer, turnover of key employees, and loss of a manufacturing plant
- A previous 409A valuation has aged one year
- Generating first revenue or profits
- GAAP financial reporting purposes
Ill-performed 409A valuations can leave employees at risk of incurring tax penalties. To avoid such penalties, it’s crucial for deferred compensation to be valued by an independent valuation firm. Scalar is committed to providing accurate, timely, and unbiased opinions of value that will withstand scrutiny by auditors, attorneys, lenders, and regulatory agencies. Our focus on valuation enables us to attain the highest level of technical proficiency and maintain superior valuation standards.