# 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.

Source: https://lopifi.com/learn/employee-stock-options-iso-vs-nso/409a-valuation-and-strike-price
Part of: Lopifi — US GAAP books on autopilot, checked by a CPA (https://lopifi.com)

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**What is a 409A valuation and why does it set 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](https://lopifi.com/md/glossary/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](https://lopifi.com/md/glossary/409a-valuation): an independent appraisal dated no more than 12 months before the grant is presumed reasonable.

> “an amount equal to 20 percent of the compensation which is required to be included in gross income.”

— [26 U.S.C. §409A(a)(1)(B)(i)(II)](https://www.law.cornell.edu/uscode/text/26/409A), Deferred compensation that fails §409A: income now, interest, and 20% more

> “as of a date that is no more than 12 months before the relevant transaction to which the valuation is applied”

— [Treas. Reg. §1.409A-1(b)(5)(i)(A), (b)(5)(iv)(B)(2)(i)](https://www.law.cornell.edu/cfr/text/26/1.409A-1), Options at fair market value are outside §409A; an independent appraisal is presumed reasonable

**Northwind — The November appraisal.** Northwind's appraisal is dated November 16, 2026 at $0.06 a share, after the SAFE. Grants on December 1, 2026 at $0.06 are inside the presumption, which covers grants through November 16, 2027 — unless something material changes first, like the Seed. Granting at the founders' $0.0075 instead would have put $3,412.50 of spread in the employees' hands on day one, and the 20% problem with it.

**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 page's rules come from

- [26 U.S.C. §409A(a)(1)(B)(i)(II)](https://www.law.cornell.edu/uscode/text/26/409A) — Deferred compensation that fails §409A: income now, interest, and 20% more (statute)
- [Treas. Reg. §1.409A-1(b)(5)(i)(A), (b)(5)(iv)(B)(2)(i)](https://www.law.cornell.edu/cfr/text/26/1.409A-1) — Options at fair market value are outside §409A; an independent appraisal is presumed reasonable (regulation)

## Read further

- https://lopifi.com/md/startups/stock-options-409a-and-vesting
- https://lopifi.com/md/accounting/409a-valuation

- **Track:** [Cap tables & raising](https://lopifi.com/md/learn/equity)
- **Part of:** [Employee stock options: ISOs, NSOs and RSUs](https://lopifi.com/md/learn/employee-stock-options-iso-vs-nso) — 5 min
- **Terms taught:** [409A valuation](https://lopifi.com/md/glossary/409a-valuation), [Exercise price](https://lopifi.com/md/glossary/exercise-price)
- **Previous:** [Employee stock options: ISOs, NSOs and RSUs](https://lopifi.com/md/learn/employee-stock-options-iso-vs-nso)
- **Next:** [The $100,000 ISO limit and early exercise](https://lopifi.com/md/learn/employee-stock-options-iso-vs-nso/iso-100000-limit-and-early-exercise)
- **The course:** https://lopifi.com/md/learn