What is a 409A Valuation?

409A valuation is an independent appraisal of the fair market value (FMV) of a private company’s common stock by an independent third party. It is named after Section 409A of the Internal Revenue Code, which was enacted in 2004 to prevent executives from taking advantage of equity loopholes. 409A valuations are used for several purposes, such as raising capital from investors, selling the company, and complying with tax laws. 

Why does a 409A Valuation Matter?

In the case of an ESOP, the company’s stock is being granted to its employees. The fair market value of the stock will be used to measure the value of the employee’s holding and the price that an employee will get when the company buys back that stock at retirement. Learn more about how ESOPs are employee retirement accounts.

Who can perform a 409A Valuation?

This valuation is typically performed by experienced experts, financial analysts, or certified public accountants with the necessary qualifications, credentials, and expertise. The professional chosen to conduct the valuation must have a deep understanding of the Internal Revenue Code Section 409A, which mandates these valuations, and experience in evaluating the worth of private companies.

The key is that the individual or firm conducting the 409A Valuation must be able to withstand scrutiny from the IRS and provide a robust, defensible valuation that accurately reflects the company’s worth.

While it might be tempting for companies to perform this valuation internally to save costs, the risks associated with non-compliance, such as penalties and reputational damage, often outweigh the benefits. Engaging qualified, experienced, and independent professionals or firms to conduct a 409A Valuation is generally the safer and more prudent approach.

private company valuation

How to prepare for a 409A Valuation

Here are some tips on how to prepare for a 409A valuation of your small business by Sharevance, including itemizing discretionary expenses:

  1. Gather your financial information. This includes your company’s income statements, balance sheets, and cash flow statements for the past three years. You should also have your company’s most recent valuation report, if available.
  2. Communicate your key performance indicators (KPIs). KPIs are metrics that measure your company’s performance in key areas, such as revenue growth, profitability, and customer satisfaction. How have you measured success inside your company? Sharevance will use your KPIs to assess your company’s value.
  3. Itemize your discretionary expenses. Discretionary expenses are expenses that are not essential to the operation of your business. These expenses may include things like travel, entertainment, and marketing. Sharevance may need to adjust for some of these expenses to make it easier to compare your company to others in your industry. Review your credit card statements and bank statements to identify all of these expenses.
  4. Understand your company’s industry. Sharevance will compare your company to other companies in your industry to assess its value. It is important to have a good understanding of your industry and the competitive landscape.
  5. Be prepared to answer questions. Sharevance will ask you a number of questions about your company, its finances, and its future prospects. Be realistic. We will consider many factors when determining your company’s value, including its financial performance, industry trends, and the valuation of similar companies in your industry.

By following these tips, you can prepare for a 409A valuation of your small business by Sharevance and ensure that you get a fair valuation for your company. 409A valuations may be unfamiliar, but by preparing ahead of time, you can help ensure the valuation process is smooth and efficient.