409A Valuation Vs. Fair Market Value (FMV): What's The Difference? - dodo

When issuing stock alternatives or structuring payment strategies, lots of founders encounter 2 important-yet typically misunderstood-terms: 409A Valuation and Fair Market Value (FMV). At a glimpse, they might seem interchangeable. In practice, they serve different legal, tax, and functional functions. Understanding the difference in between 409A vs FMV is important for private companies, specifically startups, that desire to stay compliant and competitive.

In this guide, we'll break down:

- What is a 409A assessment?

What is Fair Market Value (FMV)?
How the IRS views each
The relationship between 409A and FMV
Why the distinction matters for equity compensation
Common misunderstandings and errors
Best practices for start-ups

Let's dive in.

What Is a 409A Valuation?

A 409A evaluation is a formal, independent appraisal used to figure out the reasonable market price of a personal business's common stock. It gets its name from Section 409A of the Internal Revenue Code, which governs non-qualified delayed compensation.

Startups usually utilize a 409A appraisal to set the strike cost of stock choices released to employees. Legally, the strike rate should not be lower than the FMV of the underlying common stock on the grant date. A 409A evaluation assists guarantee compliance with this guideline.

For business using Mantle's cap table management platform, the 409A evaluation can be structured for simple tracking and compliance.

Key Features of a 409A Valuation:

- Conducted by a third-party assessment company
Required for independently held companies issuing stock choices
Must be updated every 12 months or after a product event (e.g., fundraising, acquisition deal).
Provides a "safe harbor" to protect companies and employees from IRS charges

To learn more on 409A assessments, have a look at our guide.

What Is Fair Market Value (FMV)?

Fair Market Value (FMV) is a broader financial idea specified by the IRS as:

" The rate at which the residential or commercial property would alter hands between a willing buyer and a willing seller, neither being under any obsession to purchase or to offer and both having affordable knowledge of relevant facts."

FMV can be used in several contexts:

- Sale of company shares or assets.
Gifting of equity for estate or tax preparation.
Purchase of stock options.
Mergers and acquisitions

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

409A Valuations vs. Fair Market Value: Key Differences

Here's how 409A appraisals vs. reasonable market price compare across essential locations:

For a more comprehensive take a look at compliance and evaluation dangers, have a look at our post on 409A evaluation guide.

How the IRS Views 409A Valuations vs. FMV

The IRS uses 409A evaluations particularly to regulate deferred payment, such as stock alternatives. If a business issues alternatives with a strike cost below FMV without a vlid 409A assessment, the comployee might deal with:

- Immediate earnings tax on the postponed settlement.
An additional 20% penalty tax.
Interest charges on overdue taxes

Safe Harbor Protection

A certified 409A assessment supplies a safe harbor, moving the burden of evidence to the IRS. To quality:

- The appraisal must be performed by a qualified independent appraiser.
It must be less than 12 months old.
There must have been no material changes impacting the appraisal.

FMV, on the other hand, is a general principle used by the IRS in lots of tax-related scenarios-not just equity payment. which transfers of residential or commercial property are judged for tax purposes.

Why the Distinction Between 409A and FMV Matters

Understanding 409A assessments vs. fair market value is important for:

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

A typical error is assuming the FMV equals the most recent favored stock price. However, favored shares often bring liquidation preferences and investor protections, meaning they deserve more than typical stock.

A 409A Valuation represent:

- 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 say your startup raises a Series A round at $10/share for favored stock. That evaluation includes investor rights that typical shares don't have.

A correct 409A evaluation may evaluate the FMV of common stock at $2.50/ share, showing:

- Illiquidity of personal shares.
Subordination to favored stock.
Risk profile for early-stage companies

Issuing options at $10/share instead of $2.50/ share could:

- Trigger IRS examination.
Deter staff members from exercising choices.
Overstate payment cost on your books

When to Update Your 409A Valuation

To preserve compliance, upgrade your 409A evaluation:

At least every 12 months. After any product occasion, such as: - New financing round.
Acquisition offer.
Major business pivot.
Large income modification

Failing to upgrade your valuation can invalidate your safe harbor status and expose the business to tax and legal risk.

You can discover more information on when to update your 409A appraisal here.

Common Mistakes Companies Make

Relying on Internal FMV Estimates: These normally do not fulfill safe harbor requirements and often lack paperwork. Confusing Preferred and Common Stock Valuation: Valuing typical stock at the very same rate as chosen can cause overvaluation and compliance problems. Skipping Updates After Major Events: Material modifications like fundraising rounds should set off an assessment upgrade. Granting Options Without a Legitimate 409A: Retroactive rates can result in penalties and taxable income for staff members. Best Practices for Managing 409A Valuations and FMV

- Work with a respectable third-party valuation company.
Schedule evaluation updates yearly.
Update after material occasions.
Keep comprehensive records of all grants and evaluations.
Educate staff members on how stock choices and FMV work

Final Thoughts: 409A Valuations vs. Fair Market Price

While they're closely related, 409A assessments and reasonable market price are not interchangeable. FMV is the more comprehensive financial idea, while a 409A valuation is a particular, defensible method to determine FMV for releasing stock alternatives in private companies.

For startups, the best route is to deal with 409A evaluations as a legal and compliance requirement, and FMV as the structure of sound equity planning. Understanding and handling both ensures you remain IRS-compliant, bring in leading skill, and maintain openness with financiers and employees.

Need assist with your next 409A valuation or cap table management? See how Mantle can assist streamline compliance and equity management for you and your legal team.

More on 409A evaluations

409A Valuations for Startups (2025 Guide): What Founders Need to Know.
409A Valuation Cost Breakdown: What to Expect.
How to Prepare for a 409A Valuation: A Step-by-Step Checklist.
Disclaimer: This blog post is provided as basic info to clients and pals of Mantle. It needs to not be interpreted as, and does not constitute, financial, legal or tax guidance on any particular matter, and companies and employees should always consult their expert consultants, accountants or lawyers as needed when considering choices or actions that might impact your business or personal interests. Mantle does not presume any liability for dependence on the information in this blog site post.