409a Valuation for Crypto Companies

Here is what you need to know about 409a valuation for crypto companies.

409A valuation and compliance are not the most exciting parts of being a founder, but they are critical parts of the long-term success of a company. And just so you know, every kind of company needs to get itself valued so that it satisfies tax compliances set by the government. This is especially true where the founders share equity with their staff or take on outside investment.

With that said, there are companies that now have started using cryptocurrencies as their mode of exchange for raising funds, or their main line of business is dealing in cryptocurrency.

This leads to issues as the IRS needs a way to regulate these companies for tax purposes. And since they are very different from normal companies, not everyone can value them the right way. In fact, some do not understand how to get cryptocurrency companies valued. That is where Eqvista comes into the picture. Our team is equipped with the needed experience, knowledge, and understanding in valuing crypto companies. Here is what you need to know about 409a valuation for crypto companies.

409a Valuation for Crypto Companies

Just like any other company, all types of crypto companies need to get their 409A valuations done as per the IRS compliance rules. This is essential when the company shareholders file their 1040s, as their tax obligations may go beyond the number of tokens they hold. Let us first understand a bit about the 409A valuation.

Understanding 409a Valuation & It’s Importance

Having a private company means that your company’s value isn’t set by the market, like public companies. In fact, a private company’s share price is derived by the firm’s overall value. That is where the IRS Section 409A comes in. Section 409A of the IRC is a rule that states the company has to get an appraiser to find the company’s fair market value (FMV) using approved methods. The FMV determined is of the company’s common stock or the stock reserved for employees and founders. Basically, the valuation determines the cost to purchase a share in the company.

Put simply, a company cannot just offer equity without knowing the value of the shares. And to know the value of the share, you will need a 409A valuation done. Why follow the rule? If the IRS audits your company and finds the shares and tax filings are not set as per FMV, there would be adverse tax consequences for not only the company, but also for the shareholders.

These include:

  • The employees and shareholders would be taxed on the options they received immediately.
  • The employees and shareholders would have to pay an additional 20% of the value of their option grants and might have to pay other penalties as well.

When the valuation is conducted by an independent or unaffiliated party, it establishes a safe harbor status. This means that the value determined is considered reasonable by the IRS, and the responsibility shifts onto the IRS to prove the FMV calculated is mispriced (like innocent until proven guilty). Otherwise without safe harbour status, the company must prove to the IRS that the share price it calculated is accurate.

That is why it is always better to engage an independent valuation company, like Eqvista, for your company’s 409a valuation.

Factors that influence your company valuation

Many factors affect the valuation of a company, including:

  • Industry demand: The industry in which the company belongs is a huge factor, and if the company operates in a “hot” industry (where there are greater demands to make investments), the value of the company would be higher than a company of the same size and stage in another industry.
  • Market size: The size of the market also matters, where the larger the market size, the bigger the potential upside of an investment. Moreover, the market demand also matters since the investment chances reduce if the company is in a saturated market.
  • Development stage: A startup would obviously have a lower valuation as compared to a medium-sized company.
  • Future financing: The number of rounds that the company needs to reach an exit point is also another important factor.
  • Traction: If the company has evidence that it is gaining a lot of traction and high growth rates, this will lead to a higher valuation.
  • Unit economics: Being a new company, it is unlikely to become highly profitable instantly. Showing good unit economics for the service or product would display how profitable you might be in the future and would simultaneously increase the valuation.
  • Investor demand: The higher the investor demand to get in on the deal, the higher the company’s value.
  • General economy: When the economy isn’t good, the value would be low, and vice-versa.
  • Comparable companies: All the comparable companies and industries are considered when obtaining the company’s value.

Do crypto companies require a 409a valuation?

Blockchain is a revolutionary technology that has been used to power virtual currencies like cryptocurrency (also known as virtual tokens). Since it is highly popular now, companies that started raising money using “initial coin offerings” (ICOs) and using tokens to compensate and incentivize founders, directors, employees, and consultants. Due to this, the question arises on how these tokens would be viewed and regulated by the IRS and the SEC. Other companies trade in cryptocurrency or other crypto-related services and need to find the value of their company by non-traditional means and methods.

That is why the IRS has also implemented the rule of getting the 409A valuation performed for the crypto companies just as it would be for any other company.

409a valuation for Crypto companies

409A valuation also applies to crypto companies. Valuing crypto companies takes place just like any other company; that is when the company wants to issue employee deferred compensation. And as per the IRS rule, the company would need to get the 409A valuation for their cryptocurrency company. A company and token valuation is a process to determine the fair value of the crypto-token. The valuation is performed for compliance, tax purposes, and strategic purposes. It is mostly done before the issuance of a token-based deferred compensation.

Performing the 409A valuation for crypto companies is very different from performing the valuation for other companies. And not every evaluator can get the right results. At Eqvista, our team understands all the crypto space’s intricacies, including the technical and legal relationships between the companies and their foundations or related entities, the types of crypto companies, the several validation methodologies behind transactions, and the unique market position that crypto tokens operate in.

Different types of Crypto Currencies

With blockchain being a new technology, there are a lot of companies that have emerged offering different kinds of cryptocurrencies. But other than the different kinds of cryptocurrencies available in the market, there are also different types of crypto companies. Each type has been explained below:

  • Cryptocurrency Exchanges: Cryptocurrency exchanges are an online marketplace where the users are allowed to exchange one kind of digital asset for another based on the market value of the given assets. These kinds of crypto companies played a huge role in the ICO boom of 2017.
  • Cryptocurrency wallet: Another one of the types of crypto companies is the cryptocurrency wallet companies. The cryptocurrency wallet is an application that allows cryptocurrency users to store and retrieve their digital assets. Just like the traditional currency, you do not need a wallet to spend money. But this does help you keep all the money or currency you have in one place. So, these companies create the wallet where a person can easily store their cryptocurrencies to then make transactions with later on.
  • Crypto Currencies, Altcoins & Crypto Tokens: Then comes the companies that create the currencies. There were three types of cryptocurrencies, namely cryptocurrency, altcoins, and crypto tokens. These are usually used interchangeably in the virtual currency world. But they are not the same. The cryptocurrency is the superset, and altcoins and crypto tokens are its two subset categories.
    • A cryptocurrency is the standard currency that is used for making and receiving payments on the blockchain. The most popular one is bitcoin.
    • Altcoins are various alternative cryptocurrencies that were launched after the massive success achieved by bitcoin. The meaning of the term is alternative coins, that is, other than bitcoins. Some examples include Dogecoin, Namecoin, Litecoin, and Bitcoin Cash.
    • Crypto token is a particular fungible and tradable asset to a utility created over an initial coin offering (ICO), usually found on a blockchain.
  • Other types of Crypto Companies: Apart from these main types of crypto companies are companies that deal in crypto-related products and services, but not the cryptocurrency issuer or exchange itself. These companies may have a variety of crypto-related services, and maybe more difficult to value.

How does equity work in Crypto Currency companies?

Let us now understand equity and cryptocurrency. When a company completes an ICO, it is selling a coin or a “token” to the public. Unlike the IPO, an ICO does not necessarily grant the token purchaser the same ownership rights that a shareholder is entitled to under the federal securities laws. And today, there are basically two kinds of issuances of crypto tokens: utility tokens and security tokens.

Security tokens are intended to be treated as investment vehicles and have to comply with the regulatory requirements. On the other hand, the utility tokens are designed to offer token holders access to the company’s services or products or serve a specific function on its blockchain. In many cases, companies are structured as C-corporations with preferred and common shareholders while having utility tokens trading an open exchange. This introduces a new consideration for startups that have issued utility tokens and how the token value impacts their 409A valuation. In fact, there are a lot of such challenges that come into question when valuing crypto companies.

Challenges of valuing crypto companies

As mentioned above, there are a lot of challenges as it is with any form of innovation. The IRS has released guidance indicating that tokens issued to individuals in exchange for services would normally be treated as compensation subject to income and payroll taxes under the IRC and would be reported on the Form W-2. Hence, employers who are issuing tokens to employees and other service providers have to first get the fair market value of the tokens to then properly report it.

Nonetheless, the IRS does not treat tokens as currency but as a property. Due to this, based on the kind of award, the recipient might have to file an election with the IRS to tax the award at the time of the grant (an “83(b) election”). But just be clear, this can be very risky if the tokens are later forfeited or fall in value. Moreover, the IRS has not issued guidance on when token options are subject to Section 409A of the IRC. So, the issuers would have to assume that token options are subject to Section 409A and get the 409A valuation done. It is better to have it done than pay for the hefty penalties and lose your employees and/or shareholders.

Additionally, the SEC broadly considers every token offering issued to raise money as securities. Hence, employers who issue the token-based compensatory awards need to follow Rule 701 and other exemptions from registration under the Securities Act along with the applicable state securities laws. In short, the same tax, securities, and other rules that apply to compensatory equity awards may apply to compensatory tokens. So, it is always better to be safe and get the 409a valuation for crypto companies done.

409a valuation based on crypto company Stage

Just like every other company, the crypto companies also have different stages. And for every stage, the value of the currency is different and is affected by a lot of factors as well (most of which have been mentioned above). For valuing crypto companies, it is important to hire the company that has the right experience and knowledge regarding token valuation.

Eqvista has a team of professionals that hold the required certificates and have both the experience and knowledge to determine the 409A valuation for the crypto companies based on the stage of the cryptocurrency. We have created 409A valuation reports for many such clients and they have successfully gained safe harbor status. This has helped them stay away from the IRS audit and any penalties.

Get 409a Valuation for Your Crypto Company

Finally, if you have a cryptocurrency company and have not yet got your 409A valuation done and are about to go through a major event or issue currencies to employees, then we can help you. Regardless of the stage your company is in, we will offer you the most accurate cryptocurrency value for your company.

Even though you may be operating in the risky industry of crypto, there’s no need to risk your company valuation and taxes. Better to engage an independent valuation appraiser, like Eqvista, to get a company valuation for your share price.

Contact us today to discuss more about your crypto company and how to get your 409a valuation started!

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