Can any company use this tool?
Absolutely not. This tool is designed only for companies in the earliest stages of development. We highly recommend that you work with a valuation professional unless your company meets all of the following criteria:
- No reliable source of revenue or cash flow
- Raised less than $500K in investment capital
- Cap table has no preferred stock or convertible debt instruments (KISS, SAFE, etc.)
- Company does not reasonably anticipate an IPO in the next 180 days or an acquisition in the next 90 days
- There has been no buying or selling of shares of the company's stock
- Company's assets are worth $100k or less
Why would I use this tool?
A formal valuation opinion costs thousands of dollars. For a company that just started, this type of expense is hard to justify. Why hire someone to tell you that your company with no revenue and no assets is worth nothing?
But you still need some sort of written analysis to document how you determined the strike price for options. This tool makes it easy to perform a simple calculation and produce an automated report of the analysis. For free.
Why do I need a 409A valuation?
The IRS requires you to issue options with a strike price equal to the fair market value (“FMV”) of common stock. In order to establish the FMV, you need a documented report that outlines the calculations and methodology used to arrive at a value per common share.
When do I need a 409A valuation?
When your company starts issuing options or other forms of equity compensation, you should perform a 409A valuation at least every 12 months. The following events trigger the need for a new valuation sooner than 12 months:
- Raising a new round of financing or receiving a term sheet for a new round of financing
- Approaching a liquidity event (merger, acquisition, IPO)
- Achieving a major business milestone (achieving first revenue, significantly increasing the rate of revenue growth, closing a massive deal, receiving an acquisition offer, etc.)
- Buying and selling of the company's shares in arm's length transactions
How much does this cost?
This tool is completely free. We believe in karma.
You do assume some additional audit risk as opposed to paying an expert or a valuation services firm to provide a valuation for you (see questions below).
How do I use this tool?
Please refer to our 409A Valuation Calculator User Guide for guidance on how to use the tool.
If you need the help of a professional, feel free to contact us and we'd be happy to provide some consultation. You might also just consider getting a formal valuation opinion.
Is this legal, valid and defensible?
The IRS has provided some guidance on the standards it will apply to a common stock valuation. For Incentive Stock Options (ISOs), they require that the company make a "good faith" effort to value the stock (see IRC 422). For Non-Qualified Stock options (NSOs), the key provision in the 409A regulations is called "safe harbor."
If a valuation qualifies for safe harbor, then the burden of proof is shifted to the IRS. Safe harbor basically means that the IRS must prove that a valuation is "grossly unreasonable" in order to challenge it. This provides enormous protection when it comes to audit and tax risk.
What qualifies a valuation as safe harbor? The following conditions must be met:
- Performed by "qualified individual(s)"" or by an independent appraiser
- Performed within the last 12 months
- Evidenced with a written report
This tool can help you meet the last two requirements, but what happens if you're not a "qualified" individual? Well, you have two options when using the 409A valuation calculator.
First, you could find a qualified individual to perform a valuation using the tool. This would usually be somebody like an angel investor or board member with significant investment experience, your head of finance, or a friend or acquaintance with experience in venture capital, private equity or investment banking.
If someone in one of those categories uses the tool to perform the valuation, they can use their experience and expertise to appeal to the safe harbor provision. The IRS would have to prove that their qualifications are inadequate and that their assumptions and results are grossly unreasonable.
Second, you can simply use the tool yourself and perform a valuation that does not qualify as safe harbor. In the event that the IRS challenged your valuation, you would be required to defend your valuation and demonstrate its reasonableness. However, a challenge by the IRS is highly unlikely for an infant startup.
All that being said, the valuation reports generated by this tool are legal, valid and defensible. It mainly depends on the company's stage of development and who is doing the valuation. Even if an unqualified person prepares the it, the IRS will probably have a hard time challenging the valuation of a brand-new startup with no revenue and no assets.
If you do not know someone with the required skillset to perform the valuaiton, or if you do not feel comfortable performing the valuaiton yourself, you should hire a valuation professional.
What are the risks of using this tool?
Non compliance with IRC Section 409A can result in significant tax penalties to the recipient of options, not to mention added costs for the company. The biggest risk is not qualifying for safe harbor.
There are essentially three types of 409A valuations (from highest to lowest risk):
- Non safe harbor valuations
- Safe harbor valuations performed by a qualified individual (assuming your company isn’t about to exit in the next 60 days)
- Safe harbor valuations performed by a qualified, independent appraiser or valuation services firm
A valuation with this tool will fall in the first, and riskiest, category if you do it yourself and you are not a qualified professional.
This tool gives you a valuation in the second category if you are qualified or another qualified professional does it for you. (Qaulified professionals generally include angel investors, board members, friends or associates at VC / PE firms or investment banks, etc.)
To get a valuation in the last and least risky category, you must hire an independent valuation professional to provide a formal valuation opinion.
To our knowledge, since the formation of the regulations, the IRS has never taken any action against any startup for failure to comply with 409A. This doesn't mean that they never will or that you should ignore the rules. But the liklihood of an IRS action seems very remote, especially for a company in the earliest stages of development.
Furthermore, many industry experts feel that companies that have not raised significant investment from institutional investors have no need to pay a valuation services firm for a valuation. For example:
Most pre-VC financed companies that are not issuing large option grants will not incur the expense of a valuation report.
—Yokum Taku, Startup Company Lawyer at Wilson Sonsini
the company will often rely on the illiquid startup insider valuation safe harbor...the company will often have an officer who is running the startup’s financial operations and who would qualify to perform such a valuation” perform the valuation.
—Trent Dykes, DLA Piper
So while you do incur additional risk by using this tool, we think the risk is managable, and almost negligable, for brand new startups (see the first question in the FAQ).
Is this tool as reliable as an independent valuation services firm?
Definitely not. But this tool is free, and valuation services firms will generally charge thousands of dollars for a formal valuation opinion.
We think that the risk / benefit of using this tool can often make sense if your company meets the criteria outlined in the first question of the FAQ.
Where can I get a safe harbor valuation?
If you're not qualified yourself, and you don't know any qualified professionals to help you use this tool, then your best option is to get a formal valuation opinion.
We've partnered with top-tier valuation service providers that will provide you with quality, low cost valuations with fast turnaround times.
This service is available on the Capshare platform starting at $99 / month.