Understanding the Impact of 409A Valuations on Stock Options Upon Joining a Company
When joining a startup or a growing company, one of the most significant benefits offered to employees, especially for early-stage hires, is stock options. These options come with a specific strike price or exercise price, which can significantly impact your financial future. However, the exact strike price can sometimes be unclear, especially if a 409A valuation occurs before the next board meeting. Let's explore when you receive the strike price based on the prior 409A valuation versus the updated one.
Typical 409A Valuation Cycle
When you join a company and are granted stock options, the strike price is typically based on the most recent 409A valuation at the time of your grant. A 409A valuation is an appraisal of the fair market value (FMV) of a company’s stock options. This valuation is critical for tax purposes and helps determine the strike price for those stock options.
However, the trajectory of a startup's valuation can often change. If a new 409A valuation occurs before the next board meeting, it is important to understand how this affects your options. Generally, you will receive the strike price based on the prior 409A valuation, assuming your options are granted before the new valuation becomes effective. This is backed by IRS regulations and common industry practices.
Actionable Insights
When joining your company: If you join and your options are granted on or after the new 409A valuation, you will receive the strike price based on the updated valuation. If you join and your options are granted before the new 409A valuation becomes effective, you will receive the strike price based on the prior valuation.
Valuation Sequence Example
Let’s illustrate this with a concrete example. Suppose the company’s common stock is valued at 1 according to IRC 409A as of December 1, 2013. On Jan 1, 2014, you join the company. On Feb 1, 2014, the new valuation comes in at 1.5.
Now, if the company grants you options on January 1, 2014, the strike price will be based on the old valuation of 1. Conversely, if the options are granted on February 1, 2014, the strike price will be based on the newer valuation of 1.5. This valuation will remain in effect for one year, until another new valuation is performed.
Additional Considerations
Some companies might negotiate to issue equity using the previous 409A valuation, especially if the last 409A valuation and FMV are still valid for less than 12 months. This can be advantageous if the difference between the two valuations is slight. However, ultimately, the company retains the decision on how best to proceed with the issuance of equity.
It is crucial to consult with your HR or legal team for specific details and to understand the unique practices of your company. They can provide guidance tailored to your situation, ensuring you fully grasp the implications of any 409A valuation changes.
Whether you are an employee looking to understand your stock options better or a company hoping to navigate the complexities of 409A valuations, a clear understanding of these nuances is essential for making well-informed decisions. Don't hesitate to reach out to HR, legal, or financial professionals with any specific questions. Your personal and professional future might depend on it.