Why companies get one
Stock options are usually granted with a strike price equal to the fair market value of the common stock. If the price is set too low and the IRS later disagrees, the person receiving the option can face additional tax and penalties under Section 409A. An independent valuation gives the board a supportable number.
When you need one
Get a valuation before the first grant of options. A valuation is generally considered reliable for up to twelve months, but a material event, such as a financing, a major contract, or a significant change in the forecast, can make it stale sooner. Do not grant options on an old valuation after something important has changed.
What the appraiser asks finance for
The valuation firm will request financial statements and a trial balance, a current cap table, the terms of each class of stock and any SAFEs or notes, the most recent financing documents, a forecast and the assumptions behind it, a list of recent significant events, and any offers or discussions about a sale. Having these ready shortens the process and avoids delays in granting options.
Make the books and the story agree
The valuer will compare the financial statements with the forecast and the cap table. If they do not agree, expect questions. Reconcile the cap table to the ledger before you share it, and be ready to explain unusual items.
What to keep
Keep the valuation report, the board approval adopting it, the date of the valuation, the list of grants made on it, and the information given to the appraiser. If the IRS or a buyer asks, the file should show how the strike price was set.
Why the strike price can sit below the round price
Investors in a priced round usually buy preferred stock, which carries rights that common stock does not, such as a liquidation preference. Options are granted on common stock, so the valuation of common is normally lower than the price per share investors paid. That gap is expected, and it is the reason a separate valuation exists.
A timeline that works
Say the board adopts a valuation in March and grants options in April and June. Both grants can rely on it. In August the company closes a priced round. A grant in September should wait for a fresh valuation, because the round is exactly the kind of event that changes what common stock is worth. Put the refresh on the calendar the day a term sheet is signed, so grants are not held up later.
Frequently asked questions
Do I need a 409A valuation for every grant?
You need a current, supportable valuation at the time of each grant. One valuation can cover several grants while it is still valid.
How much does a valuation cost?
Fees vary by provider and complexity. Ask for quotes and what is included.
Does a new financing invalidate it?
It often does. Treat a priced round or major event as a reason to refresh.