The Founder Guide to 409a Valuations in 2024
The 409A Valuation Services market was valued at USD 10 billion in 2023 and is projected to grow to USD 40.5 billion by 2031, with a compound annual growth rate (CAGR) of 12.9% from 2024 to 2031. A 409A valuation has been an indispensable and crucial assessment for a startup when issuing stock options or Restricted Stock Units (RSUs) to employees. It primarily serves two purposes,
- Ensuring stock options are priced at fair market value.
- Complying with IRS regulations to prevent hefty penalties.
Also, a 409a valuation for your company can instill investors’ confidence, recruit and retain top talents, and set a reliable benchmark for future valuations. But you need an expert’s guidance to begin.
At Eqvista, we have seasoned experts with up-to-date knowledge about valuation challenges and trends to perform our 409a valuations. Trusted by over 14,000 companies, our platform has valued businesses of all stages and sizes. So here is a guide with insights from our experts on conducting 409a valuations in 2024.
Understanding the 409A Landscape in 2024
According to the report from Verified Market Reports, the 409A Valuations Services market was valued at $X billion in 2023 and is expected to reach $A billion by the end of 2030, growing at a compound annual growth rate (CAGR) of 10% during the forecast period of 2024-2030.
The market size for 409A valuation services was valued at around $100 billion in 2023. It is expected to reach $194.87 billion by the end of 2030, with a projected compound annual growth rate (CAGR) of 10% during the forecast period of 2024-2030.
409A valuation is derived from section 409A of the US tax code. Any company that plans to offer an employee stock option program (ESOP) should need a 409a valuation,
- This valuation not only helps establish the FMV but also sets the “strike price”—the price at which employees can buy the stock. It needs to be at or above the FMV to avoid IRS violations.
- Getting a 409A valuation for startups is a regulatory step. Not aligning these values can lead to the risk of non-compliance with the 409a valuation for startups and heavy penalties from the IRS. If you’re considering providing equity, this valuation is your first step toward a clear and compliant equity plan.
So, getting a 409A valuation and refreshing it yearly is a mandatory process any startup needs to do.
Number of New Companies Over the Years
From 2019 to 2023, the number of startups incorporated in the United States experienced significant growth, particularly influenced by the COVID-19 pandemic.
- In 2019, approximately 3.4 million new business applications were filed. This number increased in 2020, reaching about 3.5 million.
- The upward trend continued in 2021 with approximately 5.4 million new business applications, marking a 19% rise from 2020.
- Despite a slight dip in 2022 to around 5.0 million applications, the numbers bounced back in 2023 with a record high of approximately 5.4 million new business applications.
Overall, the period from 2019 to 2023 saw a remarkable increase in the number of new startups in the U.S., reflecting a dynamic and responsive business environment.
2019 | 2020 | 2021 | 2022 | 2023 | |
---|---|---|---|---|---|
Number of New Companies | 3,479,111 | 3,565,531 | 5,388,282 | 5,059,710 | 5,442,215 |
This data shows that we are in a record high era of new startups entering the market. This also means an influx of new founders, employee stock option plans, and a high demand for 409a valuation providers to service these companies.
According to data, the 409A valuation industry is projected to:
- The market size was valued at approximately $10 billion in 2023 and is expected to reach $40.5 billion by 2031, with a projected growth rate of 12.9% from 2024 to 2031.
- Another report estimates the market size to be $100 billion in 2023 and forecasts it to reach $194.87 billion by the end of 2030, with a CAGR of 10% during the 2024-2030 period.
- A third report also predicts robust growth for the 409A Valuations Providers Service market from 2024 to 2031, driven by increasing demand and regulatory compliance requirements, though it does not provide specific market size figures.
Additionally, the trend likely shows that North America, followed by European markets, is a significant player in 409a valuation services, as these regions are backed up by advanced technological advancement and a strong consumer base and preference.
409A Valuation Considerations
When conducting a 409a valuation for your startup in 2024, you must also consider the following considerations.
Remote workforce
The rise of the remote workforce in recent years has caused changes in company structures and operations. For startups, this means considering how dispersed teams impact the company’s valuation, especially regarding productivity and operational costs.
Whenever there is a deferred compensation arrangement offered to remote employees, it is subject to 409a regulations. NQDC is a legally enforceable claim to pay that is due (and subject to tax) in a future tax year, according to Section 409A. So, this should be an important consideration.
Funding environment
The funding environment today is experiencing fluctuations. When determining the startup’s valuation, it is important to consider the terms and scope of previous funding. For 409A valuation processes based on the market method, recent fundraising rounds could provide insight into the company’s worth.
Valuation firm
When selecting a valuation company to conduct a 409A valuation, several key factors must be considered.
If your company has a complex capital structure with multiple funding rounds and different share classes, ensure the valuation firm has experience handling such complexities. Choose a firm that can deliver timely and efficient valuations if your company is nearing potential exits or major milestones.
Ensure your valuation firm provides reliable, defensible, and IRS-Compliant 409A valuation that helps position your company for successful equity compensation strategies and potential exits.
The 409A Valuation Process
A 409a valuation is crucial as it provides comprehensive insights into your company’s market position, financial health, and business model. To ensure the insights are accurate, you must follow the 409a valuation process as given below.
Data collection
You cannot begin the 409a valuation process without gathering accurate data about the company. The data include
- Certificate of Incorporation
- Financial statements,
- Financial forecasts,
- Stock option agreements,
- Detailed business plans,
- Cap tables,
- Market analysis, and
- Information about comparable companies
This will help your valuator to assess your financial standing in the market and understand your growth trajectory.
Methodology selection
Every startup is unique. So, your valuation firm will tailor your valuation methodology based on specific conditions like industry, development stage, and purpose of valuation. The most commonly used approaches are:
- Income Approach- In this approach, the valuator forecasts your startup’s future cash flow and discounts it to the current value. Basically, the valuator assesses your company’s capacity to generate revenue over a considerable period. This method is ideal if your startup has a stable potential to generate income.
- Asset Approach- Under this approach, your valuator assesses all your assets (tangible and intangible) and liabilities. Using this calculation, they will arrive at your company’s net asset value. This approach can be helpful if your company has considerable physical or intangible assets, even if it is not making much profit or revenue yet.
- Market Approach- To perform valuation using this approach, your valuator will select comparable companies in your industry. They calculate the FMV of your company using the multiples from these comparable companies. This method is ideal if your startup has raised funding but has not started making profits. Once the methodology is finalized, the valuator will begin the calculation.
Report generation
After calculating your company’s valuation estimates, the valuator prepares the report. To make it as transparent and compliant as possible, the report will list all the analyses made, valuation methods used, and calculations done. You must carefully document this report as it is crucial for any IRS-compliance audits in the future.
Pre & Post Funding 409a valuation
409A valuation analyses and estimates the fair market value (FMV) of a company’s common stock. The timing on when the 409a valuation also matters to a startup, notably pre & post funding.
Pre-Funding
The valuation is necessary for compliance with Section 409A of the IRC, which regulates the taxation of non-qualified deferred compensation.
Additionally, it enables employees to file an 83(B) election, minimizing tax liabilities and optimizing tax treatment on future gains.
Section 409A requires private companies to obtain a 409A valuation to determine their common stock’s fair market value (FMV) before granting stock options or other equity-based compensation.
Post-Funding
Post-funding valuations account for the influx of capital, changes in the company risk profile, and other factors affecting the company’s market value.
This ensures that new stock options granted post-funding are priced at a current, accurate FMV, protecting against potential IRS scrutiny.
Also an updated valuation is critical for planning exit strategies, such as mergers, acquisitions, or IPOs, ensuring all stakeholders are on the same page regarding the company’s worth.
409a Valuation Example Around Funding
Tech Corp is a software company delivering products that seamlessly integrate into everyday life, enhancing productivity, efficiency, and overall user experience. After developing their products, and having good traction among clients in the beginning, they were able to secure Series A funding from investors to expand their market.
Pre-Funding | Post-Funding | ||
---|---|---|---|
Company Value | $2,000,000 | Company Value | $10,000,000 |
Fair Market Value (FMV) (409A Valuation) | $0.05 | Fair Market Value (FMV) (409A Valuation) | $0.30 |
- The company is valued at $2 million and FMV of the common stock, as determined by the 409A valuation, is $0.05 per share.
- The company then decided to take on its initial investment in the form of a Series A funding round, from investors. The total amount of the funding was $8 million to support the company to develop its product and expand its market.
- The company’s value increases to $10 million after receiving Series A funding.
- The 409A valuation process, considering the new capital, reduced risk, and progress toward product launch recalculates the FMV of common stock.
- The new FMV of the common stock is determined to be $0.30 per share which has increased from $0.05.
By conducting a 409A valuation both before and after funding, ensures regulatory compliance, fair pricing of stock options, and a clear understanding of financial trajectory. This process helps in maintaining transparency with stakeholders and effectively managing the company’s equity compensation strategy.
Insider Tips from Eqvista Experts
Be clear about the Company’s current financial situation, which defines the valuation approach.
Pre-revenue? Then mostly likely asset-based (unless you expect high sales in the coming 12 months). Recently funded? Then backsolve is probably the best fit. Revenue generating, but no identifiable forecast? Then the valuation would be through a market approach. If an old business with steady revenue and profit, probably a mix of market & income based.
We’ve had many clients coming in wanting this approach or that approach when it doesn’t really fit. This not only makes the valuation and FMV hard to determine but also offers weak support in case of an audit
For similar company comparables, it’s useful to provide the most relevant companies in the public market for reference, even if the Company is unique.
We understand the main purpose of a new startup is to be unique, with a different offering than what the market has. But for valuation purposes, we still need to compare the company with other existing companies. So mentioning that there are no other similar comparables, doesn’t help with our analysis.
For recently funded companies, provide the detailed cap table and information of the round.
Countless times we have done 409a valuation cases for recently funded companies, and their cap table is messy and lacking a lot of information. It takes days to chase after information on share rights, liquidation preferences, stock option strike prices, and others, for the client to come back asking why it’s taking so long.
If we have a full view of the information, the analysis can be quite quick. Or at least we can generate a base range on the FMV before releasing the report.
The Strike Price is the lowest FMV you can issue options, but you can always issue higher
Some companies, after requesting their 409a, think the result is too low (feel it would affect their shareholder confidence), and request a change to increase this. Then later come back and want a lower valuation for their 83b filings or personal tax purposes.
If issuing an ESOP plan, you can issue an FMV above your 409a price. For example, if the 409a valuation comes in at $0.05, you can issue new stock options at $0.10 if you main concern is showing value to your shareholders
Trust Eqvista for Audit Ready 409a Valuation Reports!
For companies looking to offer equity-based compensation, 409A valuations are indispensable. By Understanding and properly executing 409A valuations, founders can ensure compliance, manage equity compensation programs effectively, and position their companies for future success. By conducting 409a valuations, you ensure your stocks are accurately priced, maintain investor confidence, and avoid tax penalties.
The challenge here is to find the right valuation expert!
At Eqvista, our services are tailored to meet the needs of companies of all sizes. We offer defensible valuation reports essential for IRS compliance and internal planning. Our NACVA-certified experts provide comprehensive solutions, and they come with transparent processes and competitive pricing. Opt for Eqvista’s 409A valuation services to benefit from expert handling of your valuation needs, ensuring accuracy, compliance, and strategic insight.
For more detailed insights and audit-ready valuation solutions, visit our website or call us!