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When releasing stock alternatives or structuring settlement plans, numerous founders come across two important-yet often misunderstood-terms: 409A Valuation and Fair Market Price (FMV). At a glance, they may seem interchangeable. In practice, they serve different legal, tax, and functional purposes. Understanding the difference between 409A vs FMV is important for private business, specifically startups, that wish to stay certified and competitive.

In this guide, we'll break down:

- What is a 409A valuation?

What is Fair Market Price (FMV)?
How the IRS views each
The relationship between 409A and FMV
Why the distinction matters for equity payment
Common mistaken beliefs and errors
Best practices for startups

Let's dive in.

What Is a 409A Valuation?

A 409A assessment is a formal, independent appraisal used to determine the fair market worth of a personal company's common stock. It gets its name from Section 409A of the Internal Revenue Code, which governs non-qualified delayed settlement.

Startups typically utilize a 409A valuation to set the strike price of stock alternatives released to staff members. Legally, the strike rate should not be lower than the FMV of the underlying typical stock on the grant date. A 409A evaluation assists make sure compliance with this guideline.

For business utilizing Mantle's cap table management platform, the 409A appraisal can be streamlined for simple tracking and compliance.

Key Features of a 409A Valuation:

- Conducted by a third-party appraisal firm
Required for privately held companies issuing stock choices
Must be updated every 12 months or after a material occasion (e.g., fundraising, acquisition offer).
Provides a "safe harbor" to safeguard business and workers from IRS penalties

For more details on 409A assessments, examine out our guide.

What Is Fair Market Value (FMV)?

Fair Market Value (FMV) is a wider monetary idea defined by the IRS as:

" The cost at which the residential or commercial property would change hands in between a willing buyer and a ready seller, neither being under any compulsion to buy or to offer and both having reasonable knowledge of pertinent facts."

FMV can be used in numerous contexts:

- Sale of business shares or properties.
Gifting of equity for estate or tax planning.
Purchase of stock choices.
Mergers and acquisitions

While a 409A valuation intends to establish FMV for compliance, not all FMV evaluations satisfy the standards needed under 409A.

409A Valuations vs. Fair Market Price: Key Differences

Here's how 409A evaluations vs. fair market value compare throughout key areas:

For a more comprehensive take a look at compliance and valuation threats, take a look at our post on 409A appraisal guide.

How the IRS Views 409A Valuations vs. FMV

The IRS utilizes 409A appraisals specifically to manage deferred compensation, such as stock options. If a business issues options with a strike rate below FMV without a vlid 409A valuation, the comployee could deal with:

- Immediate earnings tax on the deferred settlement.
An additional 20% charge tax.
Interest charges on unpaid taxes

Safe Harbor Protection

A compliant 409A evaluation supplies a safe harbor, moving the burden of proof to the IRS. To quality:

- The assessment must be performed by a qualified independent appraiser.
It must be less than 12 months old.
There must have been no product changes affecting the valuation.

FMV, on the other hand, is a basic concept used by the IRS in lots of tax-related scenarios-not settlement. which transfers of residential or commercial property are judged for tax functions.

Why the Distinction Between 409A and FMV Matters

Understanding 409A evaluations vs. fair market price is crucial for:

- Issuing equity grants correctly.
Avoiding pricey IRS penalties.
Preparing for audits, due diligence, and acquisitions.
Planning tax methods for executives and staff members

A common mistake is assuming the FMV equates to the most current preferred stock cost. However, preferred shares typically carry liquidation choices and investor defenses, indicating they deserve more than common stock.

A 409A Valuation accounts for:

- Capital structure (common vs. preferred shares).
Discount for lack of marketability (DLOM).
Financial performance and market comparables.
Risk profile and organization phase

Practical Example: VC Round vs. 409A Valuation

Let's state your start-up raises a Series A round at $10/share for preferred stock. That evaluation includes investor rights that typical shares do not have.

A correct 409A assessment might evaluate the FMV of typical stock at $2.50/ share, reflecting:

- Illiquidity of private shares.
Subordination to preferred stock.
Risk profile for early-stage companies

Issuing alternatives at $10/share instead of $2.50/ share might:

- Trigger IRS examination.
Deter employees from working out options.
Overstate compensation expense on your books

When to Update Your 409A Valuation

To preserve compliance, upgrade your 409A assessment:

A minimum of every 12 months. After any material event, such as: - New financing round.
Acquisition offer.
Major company pivot.
Large income modification

Failing to upgrade your valuation can revoke your safe harbor status and expose the company to tax and legal threat.

You can find more details on when to upgrade your 409A appraisal here.

Common Mistakes Companies Make

Counting On Internal FMV Estimates: These usually do not fulfill safe harbor requirements and often lack documents. Confusing Preferred and Common Stock Valuation: Valuing typical stock at the exact same price as chosen can result in overvaluation and compliance problems. Skipping Updates After Major Events: Material changes like fundraising rounds should set off an assessment upgrade. Granting Options Without a Legitimate 409A: Retroactive rates can result in charges and taxable earnings for workers. Best Practices for Managing 409A Valuations and FMV

- Work with a reputable third-party assessment firm.
Schedule evaluation updates each year.
Update after product events.
Keep comprehensive records of all grants and evaluations.
Educate workers on how stock options and FMV work

Final Thoughts: 409A Valuations vs. Fair Market Price

While they're closely related, 409A assessments and reasonable market value are not interchangeable. FMV is the wider monetary idea, while a 409A evaluation is a particular, defensible approach to figure out FMV for issuing stock alternatives in private business.

For start-ups, the safest route is to treat 409A assessments as a legal and compliance requirement, and FMV as the foundation of sound equity preparation. Understanding and managing both guarantees you remain IRS-compliant, bring in leading talent, and preserve openness with financiers and employees.

Need assist with your next 409A evaluation or cap table management? See how Mantle can help simplify compliance and equity management for you and your legal group.

More on 409A valuations

409A Valuations for Startups (2025 Guide): What Founders Need to Know.
409A Valuation Cost Breakdown: What to Expect.
How to Get ready for a 409A Valuation: A Detailed Checklist.
Disclaimer: This post is supplied as basic information to customers and pals of Mantle. It should not be construed as, and does not make up, financial, legal or tax guidance on any particular matter, and employers and employees ought to constantly consult their professional advisors, accountants or attorneys as required when thinking about choices or actions that might affect your service or individual interests. Mantle does not assume any liability for reliance on the details in this article.