When Do I Need a 409A Valuation for My Startup?
You just closed a funding round. New hires are coming in. Options are going out. Nobody on your team stopped to ask whether the 409A is still current. If it is not, the IRS may treat option grants made under an outdated valuation as non-compliant, and the tax penalty lands on your employees, not the company.
That is not a theoretical risk. It can result in real, quantifiable tax consequences.
What 409A Valuation Actually Requires
The Core Rule
Section 409A of the Internal Revenue Code requires that stock options be granted at or above the fair market value of the company’s common stock. The 409A valuation establishes what that fair market value is. Grant below it, and the IRS treats the option as deferred compensation with immediate tax consequences.
U.S. companies that grant stock options generally need a 409A valuation to support compliance.
When You Are Required to Update It
A 409A valuation is not a one-time event. It expires because it has a limited validity period. You must update it:
- annually, within 12 months of the prior valuation
- after any new funding round closes
- after receiving an acquisition offer, letter of intent, or similar indication of value
- after any significant business development that materially changes company value
The most common failure point is the gap right after a funding round. The raise closes. Hiring accelerates. Option grants go out. The 409A is stale and nobody updated it before the grants were made.
What Happens If You Grant Options Under a Stale Valuation
Options granted below the current fair market value trigger Section 409A penalties. The consequences fall on the employee, not the company:
- immediate income tax on the spread between strike price and FMV, in the year of vesting
- a 20% federal excise tax on top of the income tax
- interest penalties on the underpayment
- no shares sold, no cash received, but the tax bill still arrives
Your new hires get penalized for a compliance failure that was your responsibility to prevent.
Safe Harbor Protects You
Using an independent third-party appraiser gives you safe harbor. The IRS presumes your strike price is correct. Without it, the company may need to substantiate the valuation if challenged.
Common Founder Mistakes
Mistake #1: Granting Options After a Round Without Updating the 409A First
The round closes. The team celebrates. New hires start in January. Options go out in February. But the last 409A was done before the round and no longer reflects the company’s current value. Grants made between the round close and the updated valuation may carry 409A exposure. The fix is to sequence the update before option grants resume.
Mistake #2: Not Knowing the 12-Month Rule
Many founders assume the 409A is valid as long as nothing major has changed. That is not how it works. The valuation expires after 12 months regardless of business activity. Continuing to grant options under a two-year-old valuation in a quiet period is still a compliance failure.
Mistake #3: Treating the 409A as an Investor Document
Some founders order a 409A only when an investor or acquirer asks for one during diligence. But the 409A is a compliance requirement, not a presentation document. Waiting for someone to ask means grants made in the interim are already exposed. Maintaining the valuation on schedule is the correct posture.
10-Minute Self-Check
☐ When was the last 409A valuation completed, and is it still within 12 months?
☐ Has a funding round, acquisition offer, or major business development occurred since the last valuation?
☐ Are option grants currently going out under a valuation that predates the last round?
☐ Was the 409A completed by an independent third-party appraiser (safe harbor)?
☐ Do I know the exact strike price being used and whether it matches the current 409A?
☐ Has my attorney confirmed the valuation is current before the next option grant goes out?
If you cannot answer all six confidently, consider pausing option grants until you can.
Bottom Line
The penalty does not hit the company’s balance sheet. It can impact your employees, the people you brought on with equity. Keeping the valuation current is a basic obligation to your team.
When Did I Last Update My 409A Valuation?
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Sources Used
- J.P. Morgan, “409A Valuations: A Guide for Startups” — J.P. Morgan, https://www.jpmorgan.com/insights/business-planning/409a-valuations-a-guide-for-startups
- Sofer Advisors, “409A Valuation for Startups: 2026 Guide” — Sofer Advisors, https://soferadvisors.com/insights/blog/409a-valuation-for-startups-complete-compliance-guide-2025-2026/
- The Startup Law Blog, “409A Valuations: What Every Startup Needs to Know” — The Startup Law Blog, https://www.thestartuplawblog.com/blog/409a-valuations-what-every-startup-needs-to-know/