409A Valuation: A Step-By-Step Guide for CFOs at Growing Companies

Offering employee stock options to your team can be a game-changer. But how do you ensure your shares are priced fairly and don't cause tax liabilities or legal challenges down the line? The answer lies in a 409A valuation. For private companies, it's more than just a number—it's essential to a compliant and employee-friendly equity strategy.

You’ll need a 409A valuation before you issue your first options. It shapes how you reward talent, raise money, and grow. Get your company valuation processes right, and you’ll avoid red flags that can slow you down later.

Let’s take a look at what a 409A valuation is and when it becomes essential for your business. We’ll uncover the various methodologies and discuss why getting it right is so crucial.

We’ll also address if you really need to hire a 409A valuation firm. If so, we’ll guide you on what to consider when selecting the right firm for your needs. Plus, we’ll show you how easy it is to get your 409A valuation done through Pulley.

What is a 409A valuation?

A 409A valuation is a third-party report that sets your common share price, which is the fair market value (FMV) of your common stock. You need this to grant options without triggering taxes. FMV is what a buyer would pay for a share today, not what it might be worth later.

The Internal Revenue Service (IRS) requires this report under Section 409A, a rule from the American Jobs Creation Act. The act closed tax loopholes after Enron. Now, if you price options below FMV, your team could face steep taxes and penalties. A proper 409A protects your employees and your company.

What is the 409A valuation process?

Valuation firms use one of three methods to price your shares: asset approach, income approach, or market approach. Here's what the 409A valuation process usually looks like:

• Choose a valuation method (asset, income, or market).
• Determine company value.
• Allocate company value through a waterfall or option pricing model.
• Apply a discount for lack of marketability (DLOM) to reflect private status.
• Produce a 409A report.

What data do you need for your 409A valuation?

• Last two years of financial statements
• Articles of Incorporation and Bylaws (plus any amendments)
• Company overview
• Revenue model and growth plans
• Financial forecast for the next two years
• Recent and planned fundraising rounds
• Balance sheet as of (or near) the valuation date
• Most recent cap table

When do you need a 409A valuation?

You need your first 409A valuation before granting stock options. This locks in fair market value and shields your finance team from tax issues. Don’t wait until you hire someone or close a funding round. You need it the moment you plan to issue equity.

Getting a 409A valuation isn’t a one-time task. Your company valuation report expires after 12 months—or sooner if your company experiences a material event. That brings us to our next point.

How often do you need a new 409A valuation?

You need a new 409A valuation after its 12-month expiration or when something shifts your company’s value. These are called material events. The most common one is a new funding round. 

Material events also include: 

• Liquidity events, like an initial public offering (IPO) or mergers and acquisitions (M&A)
• Signing a large customer
• Changing your business model
• Launching a major product
• Making key leadership hires

You may need more frequent updates as you grow. If you’re moving toward IPO, your window tightens. Expect to refresh your report quarterly or even monthly. Each valuation resets your safe harbor (see below) and helps you price options the right way. It also keeps your board and auditors aligned with your company’s value.

Set a schedule for new valuations, flag events early, and keep your data ready. That way, you won’t scramble when the clock starts running.

Types of 409A valuation methodologies

We mentioned how valuation firms use one of three methods in a 409A valuation process. Each one has unique characteristics and is based on specific conditions of your startup.

Asset approach

The asset method looks at what your company owns—cash, equipment, IP, and other assets—then subtracts what you owe. Early-stage companies without revenue often use this method since it’s a simple balance sheet check.

Income approach

The income method looks at what cash flow your company might earn in the future. Your valuation firm builds forecasts and discounts them back to today’s value. Income approach works well if you’re generating revenue and can show your growth story (how your business will make more money over time).

Market approach

The market method compares your company to others that just raised funds or went public. It looks at recent deals, revenue multiples, and exits. It works best when other companies like yours are raising money or going public at strong valuations.

These methods help set your fair market value and strike price, which takes us to the next question.

What should my strike price be?

Some 409A valuation providers will say that your 409A valuation (your common share price) should land around 10% to 20% of your preferred price. However, the thinking behind that suggestion is a bit outdated.

Your strike price (also known as exercise price) should match the FMV of your common stock on the date your option grant is approved, which comes from your 409A valuation. You can’t guess or reuse a number from your last round. You need a third-party firm to run the numbers based on your new metrics, including  net income, projected growth, and revenue.

If your 409A is over a year old—or a material event just happened—you need a fresh one. Without it, your strike price may not hold up in an audit, which puts your equity plan at risk. It also creates tax issues for your team. If your strike price sits too low, the IRS could say your grant created extra income. Too high, and your team won’t see value in exercising. Your goal isn’t the lowest number. It’s the lowest number that holds up under audit.

Keep your records clean and current. Schedule your 409A updates every 12 months or sooner if needed. Set your strike price after your board approves the grant and lock that date. To stay compliant, fair, and prepared for your next milestone, file your board consent and send a copy to whomever needs it, like your legal team, finance team, or cap table manager.

Why you need to get your 409A valuation right

A 409A valuation protects your company and your team. If the IRS says your valuation doesn’t meet their rules, your option grants lose tax protection. Here are some problems an improperly done 409A valuation can create:

• Immediate income tax liability on vested options
• A 20% federal tax penalty (on top of regular income tax)
• Potential state tax penalties and interest charges
• Unexpected tax bills for employees
• Delays in fundraising rounds
• Complications during M&A or IPO due diligence

Even one bad report can raise red flags. Most investors and acquirers look for 409A compliance during due diligence. If your report is missing, outdated, or weak, it can slow—or even stop—the deal. Fortunately, there are ways to protect your 409A valuation.

What is a 409A safe harbor?

A safe harbor is a valuation method that meets certain criteria outlined in Section 409A of the Internal Revenue Code. If you use the safe harbor method, the IRS will assume your 409A valuation is reasonable unless they can prove it's “grossly unreasonable.” 

There are three ways to get safe harbor status. Each method creates a safe zone around your strike price, giving you and your team peace of mind:

• Independent appraisal: You hire a third-party valuation firm. They review your financials, cap table, and market data, then issue a formal report that sets your fair market value. This option is the most common and reliable method, but make sure the firm follows AICPA guidance and builds reports that stand up in audits. Safe harbor status helps, but it’s not a free pass—investors, auditors, and even the IRS can still question a weak valuation. If your report doesn’t hold up, you could face tax penalties, option repricing, or delays during due diligence.
• Illiquid startup formula: You follow a strict formula set by the IRS. It only works if your company is privately held, less than 10 years old, and has no way to sell shares on the open market. You will have to meet some conditions, and the valuation must be done in good faith.
• Binding formula method: You use a recent written offer from an unrelated third party to buy your stock. The offer must be specific, bona fide, and legally binding.

Do you need a 409A valuation firm?

You may not always need a firm to complete a 409A valuation. But in most cases, it’s the safest call. Here’s how to decide:

• Use a firm if you’ve raised a funding round, plan to hire, or grant options.
• Use a firm if you want IRS safe harbor protection.
• Use a firm if your board or investors ask for one.
• Don’t use a firm only if you qualify for the illiquid startup formula and meet every IRS rule.

Most CFOs don’t want to take chances here. A third-party firm gives you a signed report, full audit support, and peace of mind.

Now, here’s where things get easier.

Managing your cap table and 409A valuation in the same software platform reduces errors. You don’t need to upload data twice or waste time chasing files. You’ll stay current without switching tools.

When your equity data stays in one place, your valuation stays clean. And when the next round comes, you move faster—with less risk and fewer gaps.

What to look for when choosing your 409A valuation firm

Choosing the right auditor is crucial for ensuring your valuation is protected well. To help you find the ideal firm for your 409A valuation, keep these six essential characteristics in mind:

1. Positive reputation and credibility

Pick a 409A valuation firm that holds up under scrutiny. You should check the following about the firm:

• Track record—Ask if their reports pass audits from the IRS, SEC, or the Big Four: Deloitte, PwC, EY, and KPMG. You should also ask for their audit pass rate. For example, Pulley has a 100% audit pass rate.
• Guarantee—Look for firms that offer lifetime audit support. You want backing, not just a PDF.

2. Industry experience

Look for a firm that knows your domain so they can value your company the right way from the start. Your valuation firm should understand how businesses like yours work.

• Domain—If you’re building a tech startup, a firm that mostly works with local retail shops or real estate companies won’t be as useful. They won’t know how to value growth, product, or future revenue, which may lead to the wrong share price, extra questions during audits, and delays with investors.

3. Compliance with established standards

To avoid tax penalties, you must follow these IRS rules for a proper 409A valuation:

• Get a new valuation every 12 months (or sooner if your business experiences a material event).​
• Use a qualified appraiser who knows how to value companies like yours.​
• Make sure the valuation considers all relevant information about the value of the company.​
• Document the valuation in a written report.

4. Transparent communication and collaboration

Pick a team that asks questions, explains their process, and works with your cap table, not around it. You shouldn’t chase answers about your 409A valuation.

5. Balanced cost and quality

You don’t need the most expensive firm, but you do need one that gets it right. The best choice gives you solid work without creating problems down the line.

Low-cost 409A valuation firms may seem like a good deal, but they often cut corners and lead to the following risks:

• Overvalued shares—Some firms raise your share price to lower their risk. That makes your options less valuable to employees, which can hurt hiring and retention.
• Due diligence—Investors and acquirers will look at your 409A valuation. A missing or non-compliant report can cause investors to hesitate or walk away.

6. Scalability

Choose a firm that can grow with you, from early stage to exit, so you don’t restart every time you raise funding.

How to get your 409A valuation through Pulley

Pulley keeps the process simple so you can focus on running your company. Here’s how it works, from start to finish:

1. We create your cap table

You need a clean cap table before we start your 409A valuation. Send us a spreadsheet, a Clerky export, Carta data, or your docs. Our team builds it for you, so everything is accurate and audit-ready.

2. You request your 409A valuation

Once your cap table is live, you can request your valuation in one click. Upload any required docs, and if we need more info, a valuation expert will follow up with clear next steps.

3. You receive a draft of your report

We deliver a draft 409A valuation within five to seven business days after we get all your inputs. You’ll get an email with the report and who to contact if you have questions.

4. Once approved, we finalize your 409A valuation

Review your draft, approve it in your account, and we’ll lock in the final report. No delays or confusion—just a defensible 409A valuation ready when you need it.

Key takeaways

• A 409A valuation is a third-party report that sets the fair market value (FMV) of a company’s common stock. The IRS requires this report under Section 409A.
• A proper 409A protects the company and its team from extra tax and penalties if the valuation falls below FMV.
• If the IRS deems your valuation unfavorable, your grant options lose tax protection, leading to potential issues like immediate income tax, additional state penalties, and unexpected tax bills.
• The IRS provides a safe harbor status (assuming your 409A valuation is correct) unless proven otherwise.
• Choosing the right valuation firm is crucial for ensuring your 409A valuation is done properly.
• Pulley’s process includes creating the cap table, requesting the valuation, receiving a draft, and finalizing the valuation.

Don't let 409A valuations stress you out. Pulley empowers you with audit-ready reports, expert guidance, and a unified platform that simplifies everything. Book your free demo now and see how easy 409A can be.