The 409A valuation is not a good indicator of a company’s true value. 

You heard me right. The 409A valuation isn’t an accurate representation of how much the company you work for is actually worth.

For those not familiar with it, the 409A valuation is an IRS required independent appraisal of the fair market value of a private company’s common stock. In short, the 409A valuation determines your options’ strike price – or the price at which a company can grant stock options – which ultimately facilitates your opportunity to become a shareholder.

At first glance, this valuation may seem like a useful tool to figure out the market value of your options – and even measure the current success of your company. However, if you dig just a little bit deeper, you’ll find that the 409A valuation does not accurately reflect the market value of your equity.  And, if startup employees don’t know the market value of their options, they’ll be unequipped to leverage their equity to take control of their financial futures.

When companies are growing, they are focused on creating value for their shareholders, or in other words increasing the value of the company and shares. However, when it comes to appraising the company for the 409A valuation, in order to benefit, retain and attract new employees, they are incentivized to decrease – not increase! – their 409A valuation. Why? Because this valuation will ultimately serve as the strike price for their employee stock options  – and it is in the employee’s best interest for this valuation to be lower. The lower the 409A valuation, the less money employees need to shell out when the time comes to exercise their options. 

In fact, as a result of the recent market turmoil, many companies used the opportunity to lower their 409A valuation and made the news for doing exactly this: voluntarily slashing their valuations to benefit their employees. 

Although news outlets ran these articles with sensationalized headlines such as “Stripe’s internal valuation gets cut to $63 billion” or ”

Stripe Cuts Internal Valuation by 28%“, Stripe’s “slashed valuation” was for internal purposes: to benefit their employees and secure for them the best exercise price. It had no real impact on the market value of the company.

The real value of a company (and, ultimately, the value of its equity) is certainly not determined by the 409A valuation. The true company value is determined by what investors are willing to pay for it.

So, if the 409A valuation is not reliable, how can a startup employee find out what their equity is actually worth? In order to obtain the market value of your options, you need to understand how much investors are or were willing to pay for company stock. You can obtain this information from either within your own company or via recent secondary trade data. 

That said, today there are loads of cutting edge Fintech companies working to fill this knowledge gap and give startup employees the tools to understand the true market value of their options. And, armed with this knowledge, they can make educated decisions about their options and take control of their financial future.  

So, startup employees: do not solely rely on your 409A valuation to evaluate the worth of your options. The 409A valuation may seem like a useful tool to determine their value, but in most cases it’s mostly an irrelevant methodology that doesn’t accurately reflect the true value of your options. The real value is determined by what people are willing to pay for it – and the 409A valuation does not take this into account. 

If you’re a startup employee with stock options, it’s time to take control of your financial future by understanding the actual market value of your options.  

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• Source: https://www.finextra.com/blogposting/24274/the-409a-valuation-misses-the-mark-big-time?utm_medium=rssfinextra&utm_source=finextrablogs