The 409A valuation and the strike price
Why the strike must be at fair market value, and what a 409A appraisal's 12 months cover — Northwind's first grants.
An option whose exercise price is below the stock's fair market value on the grant date is deferred compensation under §409A — income as it vests, interest, and an additional 20% tax, all for the employee. A stock right is outside §409A only if its exercise price can never be less than fair market value at grant. For a private company the defensible way to know that value is a 409A valuation: an independent appraisal dated no more than 12 months before the grant is presumed reasonable.
Wrong
Strike = whatever the founders paid ($0.0075), or the Seed price.
Right
Strike = the 409A value on the grant date ($0.06), from an appraisal less than 12 months old.
The common's value is not the preferred's price: the Seed's price buys a preference and control rights the common doesn't have.
Where this lesson's rules come from
The sources behind this lesson's requirements, by kind. Anything marked as a convention is ours, not the rule-maker's.
- Federal statute
- 26 U.S.C. §409A(a)(1)(B)(i)(II) (opens in a new tab)Deferred compensation that fails §409A: income now, interest, and 20% moreFree to read
- Federal regulation
- Treas. Reg. §1.409A-1(b)(5)(i)(A), (b)(5)(iv)(B)(2)(i) (opens in a new tab)Options at fair market value are outside §409A; an independent appraisal is presumed reasonableFree to read
The words this page teaches
Each links to its glossary definition, which also names the authority behind it and the components that render it.
- 409A valuationAn appraisal of a private company's common stock at fair market value, so options granted with a strike at or above it avoid the tax penalties of IRC §409A. A tax safe harbor; the books measure option expense under ASC 718, often starting from the same common-stock value
- Exercise priceWhat an option holder pays per share to buy it. Set at least at fair market value on the grant date — the 409A value for a private company — to keep an option outside §409A and, for an ISO, inside §422
See also
- Stock options, 409A valuations and vesting for startupsHow option strike prices are set by a 409A valuation, how vesting and the cliff work, and why ASC 718 makes every grant an expense on your P&L.
- 409A valuationAn appraisal of your common stock's fair market value, used to set the exercise price of stock options so they aren't taxed as deferred compensation.