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The ole 409, eh? So you’ve decided to get a 409A valuation. Good for you! Make sure you get it right, and at the right time with some help from Fidelity Private Shares.

Your company is getting a lot of things right. So many things, in fact, that you might be starting to explore a particularly important stage for your fledgling biz: the 409A valuation.

Going down this path for the first time can feel a little like opening Pandora’s box. But fret not. With a little help from Fidelity Private Shares, we put together the 411 on 409As. We’ll break down the what, why, when, and how of this essential fair market valuation so your biz can continue to get even more things right—with confidence.

The 409-what-now?

A 409A valuation is the assessment of the fair market value (FMV) of your company’s stock as required for tax compliance. While that may sound straightforward, 409A valuations are often clouded by misconceptions, like that they can be generated in just a few days, or that they represent the company’s overall value.

It’s also important to note that a 409A is not the same as a fundraising valuation. Investors might set a price for preferred stock during a financing round, but a 409A valuation establishes the FMV of common stock for option grants. The two serve very different purposes, which is why the numbers rarely align.

For all the right reasons

Tax compliance rarely lights a fire in a person (good for you if you’re the exception, but it’s not exactly a topic that fuels party chatter). It’s easy to throw something like this on the back burner, but without a 409A valuation, things can boil over quickly and create a huge mess for your company.

A 409A valuation can support your business in a number of ways, including:

• IRS compliance
• avoiding tax penalties
• investor confidence
• mergers and acquisitions
• legal and financial diligence
• equity compensation
• recruitment and retention

Think of the 409A valuation as a safeguard against penalties. It also helps show investors, employees, and future acquirers that you mean business. No one wants to buy a car with a ton of parking tickets on it, and the same applies to a company with a bunch of penalties to pay off. For more details on exactly what the 409A valuation protects against, check out Fidelity’s latest guide, So, Someone Told You to Get a 409A Valuation.

An eye on the clock

Not everyone has a lawyer in their family to tell them exactly when they need this sort of thing. There are a few key points in your business’s timeline when it makes sense to have it.

For example:

• before granting your initial common stock options
• following the completion of a venture financing round
• when you’re nearing an IPO, merger, or acquisition
• on an annual basis or following a material event

Material events include things like significant contract changes that affect annual recurring revenue, substantial acquisitions, new partnerships, or regulatory alterations that expand or contract your potential market. If you’re still not entirely sure when your company needs a 409A, consider skipping the call to your uncle’s law firm and check in with Fidelity. They can help with fewer guilt trips about how you call only when you need fair market valuations.

Chart the course

So it’s fairly clear that a 409A valuation is important, and while it may not be urgent, you should have a sense of when you need one. The only problem left is figuring out how to actually get one. While it’s not exactly simple, that doesn’t mean it has to be hard. In fact, Fidelity put together a handy checklist to make things a little easier.

Once you have all the necessary materials, there are three primary methodologies to acquire a 409A valuation: the income approach, the market approach, and the asset approach.

The income approach is typically suitable for companies with substantial revenue and positive cash flow. It calculates a company’s value based on its expected future cash flows while considering associated risks.

When a company undergoes a financing round, valuation providers often utilize the option pricing model (OPM) backsolve method. The market approach assumes that new investors paid a fair market value for equity, although they receive preferred stock. Adjustments are made to determine the FMV for common stock. Other market-based methods involve analyzing financial data from comparable public companies, such as revenue, net income, and EBITDA (earnings before interest, taxes, depreciation, and amortization), to estimate the company’s equity value.

The asset approach commonly applies to early-stage companies that haven’t raised capital and don’t generate revenue. This methodology assesses a company’s net asset value to establish an appropriate valuation.

Regardless of which approach is right for your company, Fidelity’s got your back. If it’s time for you to plunge into the deep end of FMVs, don’t go it alone. Fidelity Private Shares can help you every step of the way. Plus, they have additional info regarding common pitfalls to avoid when getting your 409A valuation. It’s all in their guide.