Why Your LA Business Needs a 409A Valuation Before Stock Options
You just made an offer to a senior engineer. Base salary below market, plus stock options to make up the difference. She accepts.
Now the board has to approve the grant, and someone asks the question that should have come first. What is the strike price?
If your answer is “whatever we used last time” or “a number that feels right,” you have a problem. Stock options need a strike price at or above the fair market value of your common stock on the grant date. A 409A valuation is how private companies establish that number in a way the IRS will respect.
We covered the tax mechanics behind 409A in a separate post. This one is the practical guide: when to get one, how the process works, what moves the number, and how to choose a firm in Los Angeles.
What a 409A Valuation Actually Is
A 409A valuation is an independent appraisal of the fair market value of a private company’s common stock.
That last word matters. It values your common stock specifically, not your company as a whole and not the preferred stock your investors bought.
Why the common stock number is lower
Founders are frequently surprised that their 409A comes back well below the price investors just paid per share.
That gap is normal. Preferred stock carries liquidation preferences and other rights that common stock lacks. Common stock is also harder to sell, since there is no public market for it.
Appraisers account for both. The result is a common stock value that usually sits meaningfully below the preferred price.
What it is used for
The number becomes the floor for your option strike price. Grant options at or above it and you stay on the right side of the rule.
It also comes up elsewhere. Buyers and investors request your valuation history during diligence, and auditors review it.
The safe harbor, briefly
A valuation from a qualified independent appraiser, done properly, creates a presumption that your number is reasonable. That shifts the burden to the IRS to prove otherwise.
Our earlier 409A post covers why that presumption matters and what voids it. For this guide, the point is simple: getting the valuation right is what protects your option grants.
Why Startups and Growing Companies Need One
The short answer is that granting options without one exposes your employees to tax consequences they never agreed to bear.
Options priced too low become a tax problem
If you grant an option below fair market value, it can fall outside the exemption that normally protects stock options. The consequences land primarily on the option holder, not the company.
That is the worst kind of risk to create. The person who suffers had no say in the decision.
It protects your ability to recruit
Equity is how growing companies compete with larger employers on compensation. A defensible 409A lets you offer options with confidence and explain them clearly to candidates.
Sophisticated candidates, particularly those coming from larger tech companies, often ask how the strike price was set. A clear answer helps close the offer.
It supports later transactions
When you raise money or sell, the other side reviews every option grant you have ever made. Grants priced off a stale or missing valuation become diligence findings.
Those findings can delay closing, reduce your price, or require expensive cleanup. A consistent valuation history avoids all of it.
Timing is the whole point
The valuation has to exist before the grant, not after. Pricing options first and getting a valuation later does not cure the problem.
Build it into your process. No option grant gets approved until a current valuation is in place.
How the 409A Affects Your Option Grants
Understanding the connection helps you plan grants rather than react to them.
Strike price follows the valuation
Once the board adopts a valuation, that figure sets the minimum strike price for grants made while it remains current. Most companies simply set the strike price equal to the 409A value.
When the valuation goes stale
A valuation is generally considered current for up to twelve months. That period can end sooner if something significant happens, such as a new financing round or a signed letter of intent.
After that, grants need a fresh valuation. Using an old number after a material change is exactly how companies create the problems described above.
Plan grant timing around it
Many companies batch option grants, approving several at once shortly after a new valuation. That keeps everyone’s strike price consistent and reduces the number of valuations needed.
If you are about to raise money, consider whether to make pending grants before the round closes, while the existing valuation is still current, or after, when a new valuation will likely produce a higher number. That timing decision affects employees directly, so make it deliberately.
Board approval
Grants require board approval, and the board should formally adopt the valuation it relies on. Record both in minutes or a written consent.
Missing documentation is one of the most common diligence findings, and among the easiest to prevent.
The Process of Getting a Valuation
The process is more straightforward than founders expect, and it moves faster when you prepare.
What the appraiser needs
Expect to provide your capitalization table, recent financial statements, and financial projections. The appraiser also needs your certificate of incorporation, since it defines the preferences attached to each class of stock.
Documents from any recent financing round matter most. If you sold preferred stock recently, that price becomes a key reference point.
Have a short business summary ready as well.
How long it takes
Most valuations take somewhere between two and four weeks from engagement to final report, depending on the firm and how quickly you deliver documents.
Rush timelines usually cost more, so plan ahead.
What it costs
Pricing varies with company complexity and the firm. Early-stage companies with simple structures pay less than later-stage companies with multiple preferred classes.
Treat it as a recurring expense. You will refresh it at least annually and after material events.
After the report arrives
Review the report before the board adopts it. Ask questions about anything that looks off, particularly the assumptions about future exits and the discount applied for lack of marketability.
Then have the board formally adopt it, and price your grants accordingly.
What Moves the Number
Several factors drive where your valuation lands.
Recent financing
A recent priced round is often the strongest single input. Appraisers frequently work backward from the preferred price to estimate the common stock value, adjusting for the differences between the two classes.
Preference stack
The larger your liquidation preferences, the less value remains for common stock in many exit scenarios. A heavy preference stack generally pushes the common stock value down.
Stage and financial performance
Revenue, growth rate, margins, and cash position all matter. A company with established revenue supports different valuation methods than a pre-revenue startup.
Comparable companies and transactions
Appraisers look at valuations of similar public companies and recent acquisitions in your industry. Market conditions in your sector move the number even when your own business has not changed.
Expected time to exit and volatility
The longer and less certain the path to a liquidity event, the more the appraiser discounts common stock value.
Discount for lack of marketability
Because private common stock cannot be easily sold, appraisers apply a discount. This adjustment often represents a meaningful portion of the gap between preferred and common value.
Misconceptions Worth Correcting
Five come up constantly.
“We are too early to need one.” If you are granting options, you need a basis for the strike price regardless of stage. Very early companies may qualify for alternative approaches, but you still need to establish fair market value somehow.
“A valuation lasts a full year no matter what.” Twelve months is the maximum. Significant events can end it sooner.
“Our accountant can do it.” Independence matters. The strongest protection comes from a qualified appraiser with no financial relationship to the company.
“The lowest number is always best.” A lower strike price helps employees, but only if the valuation holds up. An aggressive number that cannot be defended protects nobody.
“It values the whole company.” It values common stock specifically, which is usually worth considerably less per share than what investors paid.
Choosing a Valuation Firm in Los Angeles
Los Angeles has no shortage of options, from dedicated valuation firms to services bundled with cap table software. The right choice depends on your stage and complexity.
Credentials and independence
Look for appraisers holding recognized valuation credentials, such as the ASA, ABV, or CVA, with substantial business valuation experience. Confirm they have no financial interest in your company and no relationship with management that would compromise independence.
Relevant experience
A firm that values companies at your stage and in your industry will understand your business faster and produce a more defensible result. Ask how many companies like yours they value each year.
Defensibility and support
Ask what happens if your valuation is ever questioned. Strong firms stand behind their work and provide support during audits or diligence.
Weighing cost against risk
Price alone tells you little. The real question is whether the valuation would hold up if challenged. Saving a modest amount on a valuation that fails under scrutiny is false economy.
A California compliance item
Option grants are securities issuances, which brings in federal and California securities law. California provides an exemption for compensatory plans that meet specific requirements, and it generally involves a notice filing with the state after the first grant.
Confirm with counsel that your equity plan qualifies and that the filing happened. Companies frequently overlook it until diligence.
Illustrative Scenarios
These are hypothetical examples showing how the issues play out, not specific client matters.
The company that planned ahead
Picture a Los Angeles software company that obtains a valuation shortly after closing its seed round. It batches option grants for three new hires within the following month, documents board approval, and refreshes the valuation the next year.
When it later raises a larger round, diligence on its option history takes a single afternoon.
The company that did not
Now picture a company that granted options for two years using a strike price the founders set informally. During acquisition diligence, the buyer flags every grant.
Fixing it requires a retroactive analysis, possible repricing, and difficult conversations with employees about tax exposure. The cleanup costs far more than the valuations would have.
The difference between the two is not sophistication. It is sequence. One got the valuation before granting. The other did not.
Getting It Right Before You Grant
A 409A valuation is inexpensive relative to what it protects. It shields your employees from unexpected tax consequences, supports your recruiting, and keeps your option history clean for future financings and acquisitions.
Get the valuation before you grant. Refresh it annually and after significant events. Document board approval every time.
Pankaj Raval and our team at Carbon Law Group advise Los Angeles founders on equity compensation, including setting up option plans, coordinating 409A valuations, documenting board approvals, and handling the California securities filings that go with them.
We also help companies clean up option grants made without proper valuations, which is more common than founders admit and far easier to fix early.
If you are about to grant options, contact Carbon Law Group at carbonlg.com before the board approves anything. Bring your cap table and your most recent valuation, if you have one.
Take the next step book your consultation today, and safeguard your brand’s future.
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