A practical guide to 409A valuations for tech and life science companies.

What is a 409A valuation?

The appraiser weighs the company's financial position, funding history, prospects and the rights attached to each class of shares, and concludes on a per-share value for common stock at a specific date. That number becomes the exercise price, or strike price, for new option grants. Because common stock sits behind preferred stock, the 409A value is normally well below the price investors paid in the latest round. That gap is legitimate, provided it is supported by documented analysis.

Why does a 409A valuation matter?

A 409A valuation matters because options granted below fair market value are treated as deferred compensation that fails Section 409A, and the penalties land on the option holder, not the company. The holder owes ordinary income tax as the option vests rather than when it is exercised, plus an additional 20 percent federal tax and interest on underpayments. An independent appraisal gives the company a safe harbor that shifts the burden of proof to the IRS.

If the IRS concludes that an option was granted below fair market value, the spread is taxed as income in the year the option vests, even though the employee has received no cash. Section 409A then adds a 20 percent federal penalty tax, and interest runs from the date the income should have been reported. Several states add their own penalty, and the bill arrives while the shares are still illiquid.

The safe harbor is the protection against that outcome. If the exercise price is based on an independent appraisal that meets the regulatory requirements, the valuation is presumed reasonable, and the IRS cannot simply substitute its own view. It must show that the valuation was grossly unreasonable, which is a high bar when the report is thorough and well sourced. Without the safe harbor, the burden sits with the company.

When do you need a 409A valuation, and how often?

You need a 409A valuation before your first stock option grant, and you need to refresh it at least every 12 months. You also need a new one sooner if a material event changes the value of the company, such as a priced funding round, an acquisition offer, a major commercial contract or a significant clinical result. A valuation older than 12 months, or one that predates a material event, no longer supports the safe harbor.

The 12-month clock runs from the valuation date stated in the report, not from the date it was signed or the last grant. A material event resets the clock early. The test is whether a reasonable appraiser would conclude that the event changed the value of the company: a priced round almost always qualifies, as does an acquirer's term sheet, a transformative contract, a licensing deal, a pivotal trial readout or a regulatory decision. Routine progress between rounds usually does not.

How is a 409A valuation actually calculated?

A 409A valuation is calculated in three steps. First, the appraiser estimates the value of the whole company using the market, income and asset approaches. Second, that value is allocated across every class of stock, options and warrants, so that common stock receives only the value left after preferred stockholders' rights are honored. Third, a discount for lack of marketability is applied because private company shares cannot be sold freely.

Step one: enterprise and equity value. The market approach applies multiples drawn from comparable public companies or recent private transactions. For a venture-backed company with a recent priced round, the most common technique is the backsolve, which works backwards from the price investors just paid to infer the total equity value that justifies it. The income approach uses a discounted cash flow model, or DCF, which projects future cash flows and discounts them to present value at a rate reflecting the risk. The cost or asset approach values the business by what it would cost to rebuild its assets, and applies only to very early-stage companies.

Step two: allocation across the capital structure. Preferred stockholders typically have liquidation preferences, conversion rights and sometimes participation rights that give them more than their pro rata share in many outcomes. Three methods model those rights.

Step three: discount for lack of marketability. Private company shares cannot be sold on an exchange, so a buyer would pay less for them than for an equivalent public share. The discount for lack of marketability, or DLOM, captures that. Appraisers typically estimate it with protective put models, such as the Finnerty and Chaffe models, which price the cost of insuring against a fall in value over the expected holding period. The result depends mainly on volatility and time to liquidity.

What is different about 409A valuations for life science companies?

Life science companies are harder to value because most have no revenue, their value depends on binary clinical and regulatory outcomes, and their capital structures are often layered with several series of preferred stock. A good 409A valuation for a biotech is built around the pipeline rather than the income statement.

The central technique is risk-adjusted net present value. Each program is modeled through its remaining development stages, and future cash flows are multiplied by the probability of technical and regulatory success at each stage, drawn from published industry data and adjusted for program-specific evidence. A compound entering Phase 2 is worth considerably more than one at preclinical stage.

Intellectual property carries much of the value, so the appraiser needs to understand patent terms, exclusivity, licensing and royalty obligations. Stacked liquidation preferences across multiple series mean common stock receives meaningful value only in the better outcomes, which the allocation must reflect. Milestone-based financings, where investors commit capital in tranches released on clinical events, need care: unfunded tranches are not yet equity, but they affect both risk and value.

What is different about 409A valuations for SaaS and tech companies?

Software companies are usually valued on revenue multiples rather than earnings, with annual recurring revenue, or ARR, as the anchor metric. Growth rate, net revenue retention and gross margin drive which multiple applies. Capital structure questions center on convertible instruments and secondary sales.

Comparables have to be growth-adjusted. A company growing at 100 percent a year does not trade on the same multiple as one growing at 20 percent, so the appraiser screens public SaaS companies for similar growth and margin profiles rather than taking a sector median.

SAFEs and convertible notes are not yet shares, but they will convert into preferred stock at a discount or valuation cap on the next round, and the model must reflect that dilution. Secondary sales, where existing holders sell shares to new investors, are useful evidence of value, but only after adjusting for block size, the buyer's motivation and whether the shares were common or preferred. Option pool refreshes change the fully diluted share count and must be reflected as at the valuation date.

What are the most common 409A mistakes?

The most common 409A mistakes are using the preferred share price as the common stock price, ignoring the economic rights attached to preferred stock, relying on a stale valuation after a material event, giving the appraiser projections that contradict the investor deck, and granting options before the report is signed. Each of these can invalidate the safe harbor and leave option holders exposed.

• Adopting the preferred price for common. Preferred stock has rights that common does not. Pricing common at the round price overstates its value and makes every grant less valuable.
• Ignoring anti-dilution and participation rights. These shift value towards preferred holders in down rounds and moderate exits, and leaving them out of the allocation produces the wrong common value.
• Stale valuations after a material event. A term sheet, a signed round or a major contract makes the existing report unreliable even if it is only months old.
• Projections inconsistent with investor materials. If the deck shows one growth curve and the model another, an auditor or the IRS will ask which one management believes.
• Granting before the report is signed. Grants approved on a verbal or draft number carry avoidable risk.

What do auditors, the IRS and your board look for?

Auditors, the IRS and boards all look for the same core things: a clear statement of methodology, inputs that are sourced and traceable, consistency between the valuation and what the company says about itself elsewhere, and documented judgment wherever the appraiser has made a choice. A report that meets those tests supports both the safe harbor and the accounting for stock compensation.

The auditor's interest comes from ASC 718, the accounting standard for stock-based compensation. The expense recorded for each grant depends on the fair value of the underlying common stock, so the 409A report is usually relied upon for that purpose too. Auditors test whether the approach was appropriate, the inputs reasonable at the valuation date, and the conclusion consistent with evidence such as financing terms or secondary trades.

The IRS, if it ever looks, asks whether the valuation was grossly unreasonable, which is a question about process as much as outcome: were the relevant factors considered and the assumptions explained? Your board, which has the legal duty to set the exercise price, needs enough from the report to say it relied on it in good faith. Short, unexplained reports fail all three audiences.

How much does a 409A valuation cost, and how long does it take?

The fee for a 409A valuation depends on the complexity of the cap table, the stage of the company and whether this is a first valuation or a refresh. A seed-stage company with one class of preferred stock is simpler than a Series C company with six series, convertible notes and warrants.

We agree scope and fee upfront, and we deliver a draft conclusion within 10 business days of a complete intake. Turnaround depends mostly on how quickly the company provides a clean cap table, current financials, projections and legal documents.

How does Codon approach 409A engagements?

Every engagement is partner-led from intake to signed report, and our practice is built around technology and life science companies, so the people doing the analysis already understand ARR cohorts, clinical probabilities of success and layered preference stacks.

For companies with employees on both sides of the Atlantic, we run 409A and UK EMI valuations under a single methodology, so the two conclusions reconcile and one team produces both. The intake is a guided checklist, we deliver a draft within 10 business days of a complete intake, and fees are agreed before we start.

Frequently asked questions

This page is general information, not tax or legal advice. It reflects US and UK rules as we understand them in October 2026; confirm how they apply to your company with your advisers.