Equity 101

Key takeaways

  • A 409A valuation is conducted by a third party and provides a valuation of a privately held company. This valuation is approved by its board of directors.

  • Every time a company goes through a funding round, it typically gets a new 409A valuation, which impacts the fair market value of the shares.

  • This valuation is the basis for the fair market value of your stock options, determining your strike price at issue and factors into your taxes when you exercise your options.

What is the value of your equity?

“I wish people would have told me and I would have been more aggressive in negotiating for more stock options,” Sam, a designer in the Bay Area, recently told Vested. They regretted not understanding the true value of their stock options when they accepted an offer that came with equity.

The fact is, it can be hard — really hard — to ascertain the worth of employee equity, especially with private companies that don’t have their current share prices listed on the stock market. To determine what their company shares are worth, private companies have to undergo what is known as a 409A valuation.

👉 Private companies typically undergo an independent appraisal every year or after a fundraising event to get a 409A valuation.

What is a 409A valuation?

Typically, startups and private companies undergo a 409A valuation once a year or after they go through a material corporate event, such as a round of funding. To do that, companies hire a third party (e.g. an outside firm) to conduct the 409A valuation and it is the appraiser’s job to analyze the cash flow and assets of the private company. (Fun fact: There are dozens of firms that offer this service.)

The appraiser's output is the 409A valuation for the company, and in turn, this underlies the fair market value (FMV) of the common stock of a private company. This valuation is approved by the company’s board. 

👉 Check out our Equity Fairness Calculator to compare the terms of your equity compensation to others in similar stage companies.

How a 409A valuation affects stock options

To better understand the importance of 409A valuations and how they work, let’s look at two examples of how a 409A valuation can impact employees — and the ability of employers to retain talent.

In March 2022, the popular grocery delivery app Instacart announced that its valuation dropped by 38.5% from $39 billion to $24 billion. It is likely that the company underwent a 409A valuation to determine this new number. A lowered valuation could potentially appear problematic in the tech talents wars — where newer employees would have lower strike prices than older employers. However, to mitigate this potential hazard, Instacart also announced that it would be re-aligning equity with the new share price. 

Meanwhile, if the current 409A valuation ends up being higher than the last round (generally the trend with startups), this will likely increase the amount of taxes due when an employee exercises their options.

For example, in 2021 neobank Chime announced it had raised a whopping $750 million in a Series G round for a new valuation of $25 billion — representing a $10 billion increase over its prior valuation. For early employees with vested options, that could be both a thrilling and terrifying dilemma: They could have a low strike price + high FMV = a real tax bill.

Where can you find your company's 409A valuation? 

To be sure, information about the 409A valuation is rarely public.  The first step to finding out your company’s 409A valuation is to ask them. Additionally,  many companies that offer stock options to employees manage the process through an online “equity portal” (e.g. Carta). Oftentimes they list the current 409A price in the equity portal that employees can access any time they want.

Additionally, ex-employees can usually ascertain it in the context of their intent to exercise their options.  Although companies may not provide it explicitly for any reason, they are ethically bound to provide it in the context of exercising options because it determines the tax liability associated with an exercise.

👉 Pro-tip: You can sign up for alerts in your Vested dashboard to keep tabs on your company's fair market value. We'll alert you when it changes.

When you hold equity, you want to stay aware of the 409A valuation and FMV of the shares as it could affect your plan to exercise your stock options. If it increases drastically, you could be hit by a hefty tax bill. If it goes down, you might ask some questions about the company’s performance or take into consideration the overall market conditions. But if it’s slowly increasing and you are settling in for a long ride – that’s likely a very good strategy.

Remember, owning equity is a marathon, not a sprint.

This material has been prepared for informational purposes only and is not intended to provide, and should not be relied on for investment, tax, legal, accounting, or other professional advice. Vested does not provide investment, tax, legal, accounting, or other professional advice. You should consult your own investment, tax, legal, accounting, or other professional advisors before engaging in any transaction or equity decision.

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