What is a 409A Private Company Valuation? How do I get a 409a Appraisal?
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Do I need a 409A Valuation?
If your private company is issuing stock options or any other form of deferred compensation or equity compensation to your employees, you must have an assessment of the fair market value of your business performed by third-party 409A valuation firms. This is to satisfy the Internal Revenue Code (IRC) Section 409A. This imposes severe penalties for compensation issued at any value other than the fair market value as of the grant date.
But what’s the difference between a 409A valuation vs fair market value given by an appraiser? It’s still a valuation you can get for your company due to a material event. However, 409A valuations are performed mostly to assist companies with setting the strike price for grants of employee stock options based on a company’s enterprise value. The company must get a valuation update at least every 12 months or more frequently if significant changes occur in the business between grant dates (such as new rounds of financing).
You can also read about valuing equity in a startup company when determining private company valuations.
IRC 409A valuations often require a contingent claims analysis to allocate the equity value among the various classes of a company’s securities. This is a requirement when the capital structure includes preferred stock or convertible instruments when we are calculating the different share prices per stock class.
What does my Appraiser Need to Get Started on a 409a Valuation?
The following is a starting point for documents that fulfill IRC Section 409a Valuation requirements. Your appraiser may ask for additional documents and information as they work through the company’s valuation. For example, we will ask business owners for a list of their competitors so we can do a comparable company analysis as one of the private company valuation methods we use, including target company precedent transactions, trading comps, cost of capital used, and the discount rate.
409a Appraisal Checklist
- Articles of Incorporation, including Amended and Restated Articles of Incorporation. If you have made any changes to your articles of incorporation, such as adding classes of shares, the rights of each class should be spelled out here.
- Management team biographies (can be a link to the relevant page of your company website)
- Year to date Income Statement for the period ending on the valuation date
- Balance Sheet as of the valuation date
- Profit and Cash Flow Projections for Use in the Discounted Cash Flow Method
- 5 years of financial statements (or since incorporation)
- 5 years of revenue, expense, and tax rate projections
- Revenue growth projections, growth rate, and justification
- Cash flow analysis, if available
- Capital expenditures forecast
- Interest rates on debts and convertible instruments
- Detailed cap table, including a vesting schedule for options and/or warrants
- Debt agreements for all outstanding debt (including convertible debt)
409a Private Company Valuation Summary
In summary, you will need an IRC Section 409a Valuation if your company issues stock options or other forms of deferred compensation to your employees. A 409a report is a fair market value assessment of a company’s common stock done by an independent appraiser, such as Business Appraisal FL|GA|HI. The valuation is for helping in setting the share value strike price for grants of employee stock options. If you are a target firm, then that will affect the EBITDA multiple, valuation multiples, and the total enterprise value or market capitalization.
Private Company Valuation Methods
How to Value a Private Company
We will use 5-7 different company valuation methods in the private company valuation process and then assign the proper weighting accordingly to come up with the proper stock price for each class of equity. For example, the free cash flow of private companies is critical in our valuation determination and one of the more important valuation techniques when valuing private companies.
You can read our article on how to value your business and how we choose the right company valuation method for your situation. The private companies valuation methodologies for your situation is critical to your specific company value.
Learn more about the other benefits of getting a business valuation here for business owners of private companies from a valuation expert. We have valued private companies worth a few thousand dollars to $100 million plus in enterprise value that are seeking venture capital.