How can a company simplify its share structure to reduce 409A valuation cost?

The cost of a 409A valuation may be different even for startups from the same industry and stage if their company share structures are different. This is why the price of 409A valuations varies so much- at the lower end, it can cost $490 but at the higher end it can cost as much as $5,000.

Along with business complexity, state of financial records, and frequency of 409A valuations, company share structures also influence the cost of a 409A valuation. Hence, simplifying the structure can help manage the cost of a 409A valuation.

An even more important reason to simplify the structure is to facilitate smoother decision-making at the board level and streamline cap table management.

So, to help you reap these benefits, we will first cover the key factors that influence the cost of a 409A valuation and how you can simplify your company share structure to reduce these costs. Read on to know more!

Factors influencing the cost of a 409A valuation

Some of the factors that can influence the cost of 409A valuations are as follows:

Company stage

Conducting a 409A valuation for an early-stage company is typically easier than valuing late-stage companies. Typically, in the early stages, there are fewer financial complexities and a simple company share structure. You will find fewer assets and there will be limited historical financial data.

Hence, 409A valuations for early-stage companies involve putting a lot of weight on the market approach.

However, a late-stage company can have multiple subsidiaries and various assets and liabilities. Over the years, these companies will accumulate investors with varying levels of rights. Some companies may even issue convertible debt.

Thus, valuing a late-stage company can be challenging and hence, its 409A valuations may cost more.

Business complexity

In 409A valuations, once the enterprise value is determined, the valuation analyst must assign value to different equity interests. So, if there is an intricate company share structure with multiple stock classes, assigning values to employee stock options becomes difficult.

Also, when a company has multiple subsidiaries or its operations are dependent on its group companies, making future projections becomes challenging. Thus, business complexity can make 409A valuations challenging, time-consuming, and ultimately, expensive.

Financial records

Parsing through unorganized and incomplete financial records may increase the time commitment required from the valuation analyst. Hence, you may need to compensate the valuation analyst for the additional time spent in the valuation exercise.

Maintaining financial records in an organized manner not only saves 409A valuation costs but also aids financial analysis, and strategic decision-making, and ensures smooth audits.

Frequency of valuations

409A valuations are required after every 12 months or every material event. If you are issuing stock-based compensation to non-employees, you will need to get a 409A valuation when you are closing the books for the year to figure out the compensation expense for the year as per ASC 718.

If you need multiple 409A valuations in a year, it would be better for you to get a 409A annual subscription like the one offered by Eqvista. This would prove to be more economical than getting many singular 409A valuations.

Ways to simplify company share structure

Some of the strategies that can simplify share structures and reduce 409A valuation costs for your company are:

Limiting equity classes

As mentioned earlier, the allocation of enterprise value to different equity classes is an important step in 409A valuations. In a company where there are numerous equity classes with differing voting rights and anti-dilution rights, assigning enterprise value to each equity interest becomes challenging.

Hence, you must be very mindful of the number of equity classes you create. Instead of granting different rights, you could simplify the company share structure by issuing the same equity interests at different levels of premiums and discounts to different shareholders. This way you can reward investors as per their contributions without creating a convoluted share structure.

Utilizing cap table software

An organized cap table makes it easy to allocate enterprise value to different equity interests. At the very least, you must ensure that you submit a cap table that groups equity interests. For instance, all common stockholders should be grouped under one header, and all preference shareholders should be grouped under another.

However, some companies neglect cap table management for extended periods. Thus, their cap table does not reflect the change in company share structure after the issuing of new shares and other equity interests.

You can solve this problem by utilizing Eqvista’s cap table management software. We enable users to add shareholders, issue shares, and remove shareholders within a few clicks. We also provide various analytical tools like round modeling and waterfall analysis which can aid equity management.

Reducing the use of complex securities

At startups and other larger private entities, various complex securities could be used to raise funds. For instance, early-stage startups may issue Simple Agreements for Future Equity (SAFE) when setting the valuation is difficult but raising funds is necessary.

Various kinds of equity interests like stock options and phantom stocks are used to attract and retain employees. Also, when shareholders supply funds in difficult times, they may negotiate for preference stocks. In high-growth companies, when shareholders enter at an early stage, they may ask for anti-dilution rights in the form of the right of first refusal (ROFR).

In larger ventures, you can expect complex securities like warrants and convertible notes.

When many such complex securities exist in the same company, it is difficult to value employee stock-based compensation. Also, having multiple complex securities can make equity management difficult and can impede board decision-making.

Hence, it is best to convert the convertible securities into common stock whenever possible and thus, simplify the share structure.

Issuing equity prudently

Equity compensations have become popular because of the potential tax benefits and growth potential. By compensating top-level employees, managers, and executives with stocks, you can motivate them to drive company growth. At the same time, the compensation may get taxed at a long-term capital gains tax rate which is typically lower than the marginal income tax rate.

However, because of these benefits and the fact that equity compensation allows companies to conserve cash, some companies end up over-issuing equity. Issuing equity frequently may also raise the required frequency of 409A valuations.

For instance, stock-based compensation to employees must be expensed at the fair market value (FMV) on the grant date. So, if you issue equity compensation to employees in 3- or 4-year cycles instead of every year, you can save on 409A valuation costs.

However, if you issue stock-based compensation to employees every financial year, you will need a 409A valuation every year.

If you issue stock-based compensation to non-employees, a 409A valuation will be required at the end of your financial year. To reduce the overall cost of 409A valuations, you can align the issuance of stock-based compensation to employees with the year-end 409A valuation. This approach minimizes the need for multiple valuations throughout the year.

Also, when you limit the frequency of equity issuances, you are preventing the introduction of diverse types of equity interests which can complicate the company share structure. This will reduce your administrative burden, simplify cap table management, and also reduce the cost of a 409A valuation.

Example of simplifying company share structure

PrimeSphere Media is a media and entertainment company that manages YouTube influencers, provides social media management services, and provides content and copywriting services. Currently, its valuation is $6.875 million.

When it was founded 5 years ago, the founders raised funds from friends and family by issuing SAFE notes. After this, it raised funds from Capitalyst Partners, a venture capital firm, by issuing preference shares and convertible debt.

In the past few years, to attract and retain key employees, the company has issued stock-based compensation.

As a result, PrimeSphere Media has a very convoluted share structure.

Equity holder	Equity type	Number of units	Value of stake	Ownership
Founder #1	Common stock	250,000	$855,632	14.55%
Founder #2	Common stock	250,000	$855,632	14.55%
Founder #3	Common stock	250,000	$855,632	14.55%
Founder #4	Common stock	250,000	$855,632	14.55%
Angel investor #1	SAFE notes	Converts to 80,000 shares	$273,802	N.A.
Angel investor #2	SAFE notes	Converts to 60,000 shares	$205,352	N.A.
Employees (Vested and exercised stock options)	Common stock	31,250	$106,954	1.82%
Employee option pool	Stock options	187,500	$641,724	10.91%
Capitalyst Partners	Preferred shares	500,000	$1,711,263	29.09%
Capitalyst Partners	Convertible debt	Converts to 150,000 shares	$513,379	N.A.
Total			$6,875,000	100.00%

PrimeSphere Media decided to convert the convertible securities to simplify the company share structure. After converting the SAFE notes and convertible debt, PrimeSphere Media’s cap table looked like this:

Equity holders	Units	Value of stake	Ownership
Common stockholders	1,321,250	$4,522,013.07	65.77%
Preference shareholders	500,000	$1,711,263.22	24.89%
Employee stock option pool	187,500	$641,723.71	9.33%
Total	2,008,750	$6,875,000	100.00%

With this simplified company share structure, PrimeSphere Media is bound to save on 409A valuation costs.

Eqvista – Accurate 409A valuations that don’t break the bank!

If you have noticed that the cost of a 409A valuation is too high for your company, one of the causes could be a complicated share structure. This can be a good opportunity for you to simplify the company share structure. An immediate measure you can take is to convert any long-standing convertible securities. You could also optimize your stock compensation granting schedule to reduce the number of 409A valuations required in a year.

You should also consistently avoid creating too many diverse equity classes to maintain a streamlined and manageable company share structure.

These tasks may appear difficult; however, the process is simplified significantly through Eqvista’s cap table management software.

If you are struggling with high 409A valuation costs, consider signing up for Eqvista’s annual 409A valuation subscriptions that start from just $990 a year. Reach out to us to know more!