Is low valuation good for employees?
In the world of startups, founders often chase sky-high valuations to validate their success. However, high valuations can lead to disadvantages like overinflated expectations and increased risks of down rounds. Conversely, low valuations can lead to dilution of ownership in fundraising rounds and raise the risk of unfavorable acquisitions.
One advantage of low business valuations is the ease of attracting investors. Another advantage is it makes stock options more attractive for employees. It can reduce tax liabilities on grant or vesting, and improve capital gains.
In this article, we will dive deeper into how low business valuations can benefit employees. Read on to know more!

Risks of high valuation
Let us briefly go over two major risks of high valuations.
Overinflated expectations
Often, when startups achieve high valuations, investors and the market will set extremely high expectations. People may mistakenly assume that a startup will maintain its high growth trajectory without considering all material facts. Moreover, some investors may get so used to high growth that when a company meets analyst expectations, they will misperceive it as underperformance.
For instance, Nvidia has shown remarkable growth over the last few years. However, investors were not impressed with its performance in Q2 2024. Did Nvidia miss earnings expectations? No.
Analysts projected sales and profits of $28.7 billion and $15 billion. The actual sales and profits were more than $30 billion and $16.6 billion.
Risk of down rounds
As companies grow overvalued, the risk of a down round increases. High valuations attract a high degree of scrutiny from investors. So, if a highly-valued startup fails to maintain its growth, or exceed expectations as seen earlier, it will find it difficult to raise funds. To keep the shop open, the startup may have to raise funds at a low business valuation.
For instance, Stripe’s business valuation was $50 billion in its Series I funding round in 2023. Just two years before this, the startup was valued at $95 billion. So, even the highly-valued payment giant had to endure a down round after the high it achieved.
While a large startup like Stripe can offer exits to investors and employees through buybacks and by facilitating secondary market share sales, smaller startups that endure a down round may not have the capability to do the same.
Effects of low valuation
To build some context, let us first understand the usual effects of low valuation.

- Dilution of ownership: If your startup gets a low business valuation, you will have to give up a larger share of equity to raise the necessary funds. Suppose you must raise $2 million and your startup is valued at $10 million. Then, you must offer a 20% stake to the incoming investor. However, if your valuation was $5 million, you would have had to offer a 40% stake to the incoming investor.
- Risks of unfavorable acquisitions:Any company pursuing inorganic growth will want to acquire companies at a discount on the actual valuation. So, if your startup gets a low business valuation, it may get targeted by larger companies pursuing inorganic growth. Although you may not be opposed to acquisitions, getting under-compensated for your equity is always unappealing.
- Ease in attracting investors: One of the core principles of investing is buying assets at a discount to reap benefits when the market correctly values said assets. Hence, if your startup gets a low business valuation, it has a better chance of attracting investors.
You may have heard of companies whose share prices show double-digit growth on listing day. For instance, Arm Holdings’ share price rose 24.69% on the listing date compared to its IPO price.
Stock market investors are unlikely to learn something new every time a company gets listed. Founders are actually offering shares at a lower valuation to ensure exits for long-time investors and to attract new investors.
Is low valuation good for employees?
Yes, it can benefit employees who receive stock options. There are two main benefits of low business valuations for employees, which are:
Lower tax liability
Typically, when a company issues stock options to its employees, the employees are taxed on the difference between the exercise price and the fair market value (FMV) of the company’s shares. The FMV of a company is established through 409A valuations. So, if a company gets a low 409A valuation, the difference in exercise price and FMV will be low. Hence, the taxable income will also be low.
Even when employees gift stock options or distribute them as part of estate planning, the taxes are calculated based on the difference between the FMV and the exercise price.
Higher gains
When stock options are first offered to an employee, the exercise price is based on the FMV. Companies often set the exercise price at a discount to the FMV. So, if a company gets on the lower end of the acceptable range, it can offer the maximum benefit to its employees.
Additionally, if a company is undervalued, there will be high upside potential. In the early stages, it is natural for startups to receive low business valuations. However, as the startup grows, employees can reap benefits when they eventually sell their shares.
Examples of low business valuations benefiting employees
In this example, we will consider two cases, one where the company gets a low and one where it gets a high 409A valuation. Here, we will look at NANOnet Corp, a startup that just onboarded Mitch Green by granting stock options.
For simplicity, we’ll treat these stock options as a signing bonus rather than as stock options with a vesting schedule. So, they vest on the date of joining.
The key details of this example are as follows:
Particulars | Case 1 | Case 2 |
---|---|---|
Fair market value (FMV) of shares | $40 | $42 |
Exercise price | $28 | $28 |
Number of stock options | 10,000 | 10,000 |
The number of stock options and exercise price are the same in both cases.
In case 1, NANOnet got a low business valuation and hence the FMV of its shares was lower than in case 2. Now, let us calculate the taxable income in both cases. In this case, the current taxable income will be the difference between the FMV and the exercise price multiplied by stock options.
Particulars | Case 1 | Case 2 |
---|---|---|
Fair market value (FMV) of shares | $40 | $42 |
Exercise price | $28 | $28 |
Number of stock options | 10,000 | 10,000 |
Taxable income ((A-B) X C) | $120,000 | $140,000 |
We can clearly see that the taxable income is lower when NANOnet has a low business valuation. Since Mitch has not yet exercised these stock options, the immediate tax liability on the extra $20,000 must be paid from his savings.
Now, let us see an example where the exercise price was set at a 20% discount of the FMV, and Mitch net exercised the stock options two years later when the new FMV rose to $78.
Particulars | Case 1 | Case 2 |
---|---|---|
Fair market value (FMV) of shares | $40 | $60 |
Exercise price (A X (1-20%)) | $32 | $48 |
Number of stock options | 10,000 | 10,000 |
FMV 2 years later | $78 | |
Gain per option (D-B) | $46 | $30 |
Total gains (E X C) | $460,000 | $300,000 |
We can clearly see that Mitch’s total gains were better in case 1 when NANOnet got a low initially.
Empowering Startups, Protecting Employees: Eqvista’s 409A Valuations
We started this article by noting the risks of high valuations, namely overinflated expectations and risks of down rounds. This typically results in dilution of ownership, increases the risk of unfavorable acquisitions, and at the same time, makes attracting investors easier.
Then, we shifted our attention to how low business valuations can benefit employees. Firstly, it reduces the taxable income when stock options are granted or vested. Secondly, it allows employees to capture more of the future capital gains.
However, here, we must warn you about business valuations that are too low. This may be deemed unreasonable by the Internal Revenue Service (IRS). As a result, your employees may have to pay hefty tax penalties.
As a seasoned 409A valuation provider, Eqvista can help you maximize your employee’s gains while maintaining tax compliance. Reach out to our team to know more!