Every new venture starts with a dream. If you are a budding entrepreneur whose dream it is to start an innovative company, the road to making that dream a reality is loaded with twists and turns. Like signposts on a real highway, you’ll rely on myriad useful (and necessary) information to guide your journey and mark its progress. Think of a 409A valuation as a major milestone on your road towards the operational launch of your startup. In this article, we’ll explore the range of 409A valuation costs, what you get for your money, and how to choose the right provider.
The Problem with 409A Valuation Costs
Recall that a 409A valuation provides you with the fair market value (FMV) of your company’s common stock. You need to know your current FMV any time you issue new stock options, warrants, or stock appreciation rights. That’s because you must use your bona fide FMV to determine the minimum strike price for these instruments. Furthermore, any material change to your company—such as a new round of financing—necessitates a fresh 409A valuation. In any case, you’ll need a new 409A if your last one is more than 12 months old.
Asking the price of a single 409A valuation doesn’t tell you much if you don’t account for the frequency. To some companies, $3,000 for a valuation may seem like a drop in the bucket. $3,000 2-3 times per year, however, is another story. In determining the ideal annual cost of 409A valuations, you’ll need to multiply the quoted cost by an estimate of the number of valuations you expect to have in the course of a year.
409A Valuation Cost Depends on Approach
Your first 409A valuation usually occurs during the seed stage of your startup, with subsequent ones to follow. There are three approaches to choose from, each impacting the cost of your 409A valuation.
- Learn more about 409A safe harbor presumptions.
- Learn about the consequences of 409A non-compliance.
Do It Yourself
You can perform the 409A valuation in-house. In the short-term, this is generally cost-efficient. Furthermore, you’ll have total control over the outcome. This creates an opportunity to lowball the FMV to keep strike prices down, regardless of whether or not you have any temptation to do so. However, you’ll have no access to the safe harbor presumptions that protect you in the event of an IRS audit. As it just so happens, the government doesn’t take kindly to understated FMVs. If you go this route, you’d better have the knowledge and training to do it right; producing a pristine, perfectly accurate 409A valuation. You need to be confident enough in your valuation to risk the consequences.
Use a Software Tool
Alternatively, you can use an online 409A valuation tool. If your company is small or young enough, you may even be able to find these tools for free. As with the do-it-yourself route, using a 409A software tool fails to meet the qualifications for safe harbor presumptions. These types of tools are more popular for appraising the illiquid stock of startup corporations; the early days, when:
- Your total raise is between $500K and $1 million.
- Your equity consists of common stock, with no convertible debt or preferred stock.
- Common stock trading has yet to begin.
- You do not anticipate a change in control within 90 days or an IPO within 180 days.
Use an Outside Firm
While this is generally the most expensive solution, it can be more cost-effective in the long-run. 409A valuations are the type of thing you want to do right the first time. Given the risk involved should you fail to achieve a safe harbor valuation, paying an independent firm can save you more than paying to correct your mistakes. An independent, reputable firm will help you achieve a safe harbor valuation and can typically complete your appraisal in under a month for a reasonable price.
What to Look for in an Outside Firm
Hiring an outside firm to perform your 409A valuation is the most popular route for pre-IPO companies. However, choosing the right provider makes a big difference. There are for key factors to consider.
There is little point of using a firm that doesn’t have a good reputation. If the firm has a long history of providing high-quality, independent appraisals, there’s a good chance the IRS knows about them. There’s no hard science to it, but you probably stand a greater chance of achieving a safe harbor 409A valuation if your provider is already in the government’s good graces. The firm should have the proper credentials from the National Association of Certified Valuators and Analysts. It helps if a large auditor can vouch for the valuation provider. When the stakes are high, why settle for less?
The average 409A valuation price has declined in recent years. Some companies offer valuations on a 12-month subscription basis for a price of about $100 to $200 per month. You can also purchase valuations à la carte—usually for less than $2,000. Prices will likely increase as you progress from seed stage to Series A, B, and C+ fundraising rounds, topping off on average around $5,000. Complexity can add to the cost. If you use multiple classes of common and preferred stock or offer a variety of options, SARs, and warrants, expect the price to go higher.
A 409A valuation should be able to withstand the most withering interrogation by the IRS. This is most effective if the service provider is truly independent of your company. That means you (or your cap table software provider) should not have any material interest in the provider that might influence your appraisal. You should be able to review the firm’s track record of clients who underwent IRS audits. No firm is perfect, but they should be pretty close. The firm should agree to defend your valuations against audits for an indefinite period of time.
Normally, the preparation time for a 409A valuation is well under a month. Unless there are some reasons you need it very quickly, most firms will prepare a 409A valuation in a reasonable amount of time. Naturally, more complicated valuations will take longer. Allow a few days for data collection, a week or two to run the report, and a few more days for revisions. The biggest source of delay tends to be when the client (you) experiences delays in gathering and handing over the required data. This is why many cap table software providers package 409A valuations in with their services. They already have most of the necessary information. If you need a rush job, you can expect to pay a premium of $1,000 to $3,000, depending on the deadline.
Risk Factors When Choosing a 409A Provider
When searching for and vetting 409A valuations providers, keep an eye out for these red flags:
- The provider intimates that it can help you achieve a low strike price. You want a strike price that accurately reflects your fair market value, not a penny more. On average, the value of common stock will be less than 50% that of preferred. In some cases, that value might be as high as 80%.
- The provider doesn’t guarantee their work will qualify you for safe harbor protections.
- The provider won’t defend the valuation or respond to audit questions. The provider should be prepared to defend its work indefinitely.
- The provider lacks proper credentials (such as AVA or CVA).
- The provider has been blacklisted by one or more audit firms.
- The provider has had to withstand previous challenges to one or more valuations.
The cost of a 409A valuation shouldn’t break the bank, even for a cash-strapped startup. You will save time and money by using a firm partnering with your cap table software provider to streamline the sharing of equity data. Given the steep penalties for misstating your option strike prices, it’s worth going with a company having a solid reputation and sterling track record that will stand by you in case of an audit. At EquityEffect, we check all the boxes. Click here to schedule a demo of our equity management software and learn more about our partnerships with fully-independent 409A valuation firms.