What is the cost of a 409a Valuation?
This valuation determines the cost to purchase a share and is found by using one of the 409A valuation methods.
Do you know what a piece of your company is worth? If your company is a public company, then the value is set by the market. But in case your company is a private firm, then it all depends on independent appraisers. That is where the IRC Section 409A valuations come into the picture. A 409A is an independent appraisal of the fair market value (FMV) of a private company’s common stock or the stock reserved for founders and employees. This valuation determines the cost to purchase a share and is found by using one of the 409A valuation methods.
Why does my startup need 409a Valuation?
It was in 2005 when the IRS introduced Section 409A to prevent executives from taking advantage of equity loopholes. This section was then finalized in 2009. 409A basically creates a framework for private companies to follow when valuing private stock. This valuation is done by an unaffiliated or independent party to ensure that the valuation offers the company safe harbor status. This means that the 409A valuation is presumed to be “reasonable” by the IRS, save for a few exceptions.
Now, since it was the IRS that incorporated this section into the IRC, it is important to follow it. Valuation is not something that you can take lightly. And when your company does not follow the 409A rules and valuation methods, your equity is mispriced. And along with this, the IRS gets the right to assess penalties on your company for not following the rules. These penalties are then paid by those who own the equity in the company, which can be the shareholders and even the employees who have received equity compensation.
The goal of section 409a by the IRS was for companies to set the value of their strike price of their options to be equal to the FMV of their company’s common stock price. If the companies do not follow this, they would be facing possible tax consequences.
What is a 409A safe harbor status?
When your 409A is handled in the right way as specified by the IRS, it becomes eligible for “safe harbor” status. Basically, a safe harbor valuation is one the IRS presumes to be valid unless they can demonstrate that it’s “grossly unreasonable”. There are three safe harbor methods for setting the FMV of a private company’s common shares, which include:
- Independent appraisal presumption
- Binding formula presumption
- Illiquid startup presumption
Out of these approaches, the most common one is to achieve 409A safe harbor status using the independent appraisal presumption. This means that the company needs to use a qualified, third-party appraiser. A 409A valuation is presumed reasonable if the stock is valued within 12 months of the applicable option grant date and no material change has occurred between the valuation date and the grant date.
409a Valuation Cost
From the above, you now know that you need a 409A valuation of your company as early as possible, especially if you are about to issue stock options to justify the choice of the strike price. This is why private companies normally seek out a 409A valuation from an independent valuation service firm before issuing their options.
The normal 409A valuation costs anywhere from $1,000 to over $5,000 (can be upwards of $10,000 for very large corporations), depending on the size and complexity of your company. This ends up being closer to $1,000-$3,000 for startups and Series A companies, or $3,000-$5,000 for bigger companies with multiple rounds of funding (Series B-C). Of course, this all depends on the firm performing the valuation.
For a startup in the earliest stages of development, this seems like a huge waste of money and time, which could be used to instead grow the business. So, if your company has no revenue, no assets, and no proven business model, should you pay someone to tell you what you already know – that your stock is worth so little?
Well, ultimately you will need to decide the likelihood of a challenge by the IRS and whether you are comfortable in defending your valuation. And it is better to avoid the trouble that comes your way from the IRS by getting a 409A valuation done by an independent firm. In fact, depending on your company’s age and industry, the valuation can cost you much less than you have in mind. All you have to do is contact a professional firm to find out.
Factors that determine 409a valuation cost
As mentioned above, Eqvista can help you with getting you the 409A valuation using one of the 409A valuation methods that best suits your company’s stage, situation and industry.
Here are some key factors that will determine the price of your 409a valuation.
#1 Stage of company (Seed, Series A, Series B, Series C)
Every stage of the company has a different number of shareholders, assets that the company holds, and overall value. Due to this, it is very important to look into the stage of the company before the price of the 409A valuation is determined. A company begins with a seed funding round, which is the first funding round to help the company get on its feet. At this point, the company would not have much value, which is why the price for valuing a company at this is normally cheap as compared to when the company is in the other rounds.
After the seed funding comes in the Series A funding, which is the first Venture Capital (VC) funding that the company gets. “Series A” refers to the class of preferred stock sold. This means that the assets and the value of the company is much more than the last funding round stage. Then comes the Series B funding round that takes the business to the next level of the expansion stage.
Followed by this is the Series C funding round, which occurs to make the company appealing to support a public offering or for an acquisition. Some companies stop at this stage, while some move to further stages like the Series D funding, Series E funding, Series F funding, Series G funding, private equity funding rounds, etc. And each round makes the company bigger, where different stocks and equity options come in question. Due to this, each stage has a different price and since the efforts and calculation process gets intensified as we move to the next stage, the 409A valuation costs also increases.
#2 Size of company (revenue per year, total amount of assets)
Another factor that affects the price of the 409A valuation is the size of the company. To put it in simpler words, the smaller the company is and the lesser the complexity in the operations is, the less expensive it is. And as the company grows bigger, their operations eventually become more complex.
This tells the size of the company and it also impacts the cost of the valuation. So, as a company grows in size, the valuation process becomes tough and the 409A valuation costs increases. Keep in mind that this is just an idea on how this affects the cost. The actual costs can be determined only when the evaluator gets the financial statements of the company to see the revenue earned, the assets owned, and the operation process.
#3 Complexity of Share Structure
A simple share structure in a company is when there is only one kind of equity class and only common shares are issued. This is normally the case of when a company has just incorporated and has only the founders and some employees. But as the company grows, things become complicated. For instance, if the company wants to take up funding with just the founders and a few employees and doesn’t have a high value, that is when the company might issue convertible notes.
And as the company grows, they will be issuing warrants, employee options, preferred shares and so one. This means that as the time passes, the share structure in the company becomes more complex. So, with a complex share structure, it is tough to get the valuation done so easily. This complexity in the company share structure may contribute to a higher 409a valuation cost.
#4 Company Industry
This is an obvious factor that does affect 409A valuation costs. To elaborate, traditional businesses such as the trading company and the brick and mortar companies cost less to get a valuation done. Their company operations are more straightforward and easier to forecast future earnings. But on the other hand, specialized businesses such as tech companies or fintech companies are less predictable. The industry that the business belongs in affects the costs, since every industry has a different value and way on how things are done.
So it is important to look into the industry, understand its value, see how things are valued in the industry, and value the assets of the company as such. In fact, a brick and mortar company might have a product that they are selling, such as clothes. It is much easier to get the value for this kind of company as there is something tangible that can be measured. But when it comes to the tech companies, they usually have services or software products. In this case, valuing the services based on knowledge and industry experience takes in a lot more effort. This is why it is more costly.
#5 Age of company
The next factor is the age of the company. Now, here you might think that the newer the company, the cheaper it would be to get a 409A valuation. But that is not true. This is because a new company does not have any stable operations going on. And due to this, it takes longer to forecast the sales of the company and gets the value. This just means that it may cost a bit more, depending on other factors involved.
On the other hand, when the company is much older, it would already have stable operations. This may be easier for the valuator to predict future sales of the company, and thus justify a lower 409a valuation cost.
#6 Other factors that affect 409a valuation costs
There are other factors as well that can affect the 409A valuation costs including possible pending court cases, intangible assets, and so on. These things would increase the cost of the valuation. While other things like organized and clear sets of records and documents, and a history of 409A valuation reports in the past would help reduce the cost as it reduces the work needed to get the value of the company.
Methods for doing a 409a Valuation
With that said, you need to know that there are different ways to get your 409A valuation done. But keep in mind that it is always suggested to secure safe harbour status for your company, as it will save you a lot of time and effort later on.
The various 409A valuation methods include:
#1 Do it yourself
If you have read everything above and still feel that you can do the valuation by yourself, it’s important that you have the needed knowledge, experience, education, and training to perform a 409A valuation.
If you are experienced in the field of valuation, this method can help your company save a lot of money to get the 409A valuation done by yourself. You will also have much higher control over the valuation of the common stock of your company. But keep it in mind that if you make any mistake and there is an IRS audit, it may be more difficult to defend yourself.
Additionally, by doing it yourself, you would not get the safe harbor protection. A company can get the safe harbor status if the 409A valuation is performed as per the IRS rules, which is typically done by a third-party professional. Otherwise, your company will have the burden of proof for the company valuation, rather than the burden falling on the IRS. However for eligible companies (see iIlliquid startup exception) this could be an option.
#2 Use valuation software’s
The next 409A valuation method is to use valuation software. Now, there are two types of software applications that you will find online. One would be the paid and other free. While using free software may save you money, paid software usually offers a more accurate valuation for your company.
You will again not get the safe harbor protection using this method. And in case the IRS comes to audit your company, the burden of proof would be on you. Moreover, not everyone can use the software. You may need to fit certain criteria for the inputs of the company data to make sense for the ultimate valuation. Therefore, this option may also not be the best choice.
#3 Get expert consulting from a valuation service provider
The last option would be to hire a professional valuation service provider. And the best way to see how much the 409A valuation would cost you based on your company, you can call them up and discuss the details. You even have different choices to choose from.
This option has the highest 409a valuation cost, but it would also get you the safe harbor status. You will not have the burden of proof when the IRS comes to audit your company. But ensure the valuation firm is experienced, knowledgeable, and provides reliable service for your company. This outside 409a valuation would reduce your risks when it comes to safe harbour status and any possible penalties from the IRS later down the road.
The way to begin this is by contacting the valuation firm.
Eqvista offers 409a Valuation starting at $1,100
With all that said, Eqvista is a professional valuation service provider on the market. Our team at Eqvista believes in offering affordable and efficient solutions for companies managing their company equity. Our 409A valuation costs begin at $1,100 and go up based on your company’s age, history, industry, and more.
Here is the process that we adopt to get the valuation of your company:
- Hand over your data (1-5 days): This will include your cap table, articles of incorporation, financial projections, term sheets, any past 409A reports, and other required documents.
- Provide quotation, sign engagement letter and settle fees (1-7 days): We discuss a price for the 409a valuation. Once agreed upon, we will send you an engagement letter outlining our 409a valuation services, and upon signing the letter and settlement of the fees, we can conduct the valuation.
- Run the report (10-20 days): We will conduct the valuation and may ask you some follow up questions if need be.
- Review first draft (varies)
- Revisions (1-3 days)
- Final report is delivered (1-10 days)
The price of getting your company valued would be entirely on the kind of company you have, its age, industry, and other factors. So, the best way to find out how much it would cost is by connecting with us so we can understand your company better.
With this we would be able to offer you our best price for your 409a valuation. We will always be ready to explain how our prices are set and open for the best way to handle your valuation. Eqvista also offers our cap table software for managing your equity. Our application is FREE to use (for small companies).