409A Valuation vs Investor Valuation: What Startup Founders Get Wrong
The moment you raise funding, two numbers start haunting you: your 409A valuation vs Investor Valuation. They sound similar. They aren’t. If you confuse them, you risk upsetting your cap table, triggering IRS penalties, and scaring away great hires.
Let’s fix that now — so you never get blindsided again.
Why 409A Valuation vs Investor Valuation Confuses Founders
The investor just valued you at $10 million. Why do you need another valuation?
Because investor valuation is based on preferred shares and future expectations. 409A valuation is about common stock — what your employees get — and it reflects today’s fair market value.
What a 409A Valuation Actually Means
A 409A valuation is a third-party estimate of what your common stock is worth. It’s IRS-mandated under Section 409A of the tax code.
You need one before you grant options. Why? Because without it, the IRS can say you underpriced those options — triggering immediate income taxes, penalties, and interest for your team.
Here’s the official source: https://www.irs.gov/government-entities/409a-valuation-requirements
What an Investor Valuation Represents
An investor valuation reflects what investors are willing to pay for preferred shares, which come with rights like liquidation preferences and voting power.
It’s a negotiated number. It’s high on optimism and future potential. It doesn’t reflect what your company would fetch on the open market today.
Why 409A Valuation Is Always Lower Than Investor Valuation
That’s by design.
409A valuation focuses on fair market value of common stock, which has fewer rights than preferred stock.
Investors may pay $2.50/share, but your 409A might say common stock is worth $0.25/share. That’s not wrong — it’s how equity stays attractive to employees and compliant with the IRS.
The Hiring Advantage
Lower 409A = lower option strike price = more upside for your team.
This isn’t just about compliance. It’s about making equity meaningful. A lower strike price means your employees can buy shares cheaply and realize more gains down the line.
When You Need a New 409A Valuation
You need a new 409A valuation:
- Every 12 months
- After a funding round
- After signing a major contract
- After M&A interest or acquisition offers
- After secondary sales
Bottom line: any material event that impacts your company’s value triggers the need for a fresh 409A.
Why Using Your Investor Valuation Is a Huge Mistake
Some founders assume the valuation from their last round is good enough. It’s not.
Investor valuation is about preferred equity and return potential. 409A is about tax-safe strike prices for your employees’ common shares.
Confuse the two, and you’re inviting tax problems.
What Happens If You Skip Your 409A Valuation
Let’s say you grant options without a 409A valuation, or use the investor valuation as your strike price.
The IRS can:
- Reclassify options as income
- Impose a 20% penalty
- Charge interest
- Hit employees with taxes before they’ve made any money
It’s a disaster waiting to happen. And during due diligence, investors will flag this.
How the 409A Valuation Process Works
Here’s what a typical process looks like:
- You hire a qualified appraiser
- Share cap table, financials, and forecasts
- They choose a method (OPM, PWERM, Backsolve)
- You review the draft
- Final report delivered
- Option grants issued based on FMV
It’s a 1–2 week process. Easy when done right.
Common Startup Valuation Techniques Used in 409A
- Option Pricing Method (OPM) – Standard for early-stage companies
- Backsolve Method – When you’ve raised a priced round recently
- PWERM – When different exit outcomes are likely (IPO, M&A)
- Guideline Public Company Method – If you’re generating revenue and have comps
Want to learn how these methods work? https://kayoneconsulting.com/valuation-methods-explained/
“Can’t I Just Use Carta or Pulley?”
Sure, but here’s the catch:
- Cheap tools = templated assumptions
- No one defends your report in an audit
- Your unique risks and growth story? Ignored
If it’s challenged later — in an IRS audit or M&A due diligence — you’re on your own.
Here’s what expert-led valuations give you instead: https://kayoneconsulting.com/7-benefits-of-business-valuation/
What a Proper Valuation Actually Gives You
- IRS safe harbor compliance
- Defensible strike price
- Clean cap table for diligence
- Stronger hiring pitch
- Peace of mind
And it’s usually done in 2–3 weeks — for less than what you’d pay a contractor.
Why Valuation Impacts Your Cap Table Strategy
409A valuation helps you issue more options without hurting your cap table. That’s leverage. It helps you offer equity that feels meaningful — and keeps your option pool lean.
Investor valuation tells the world what you’re worth. 409A tells the IRS how you’re staying compliant.
They’re not interchangeable — but they both matter.
Founder Mistakes That Cost Thousands in Back Taxes
A founder raised $5M. Never updated their 409A. Six months later, they hired five senior engineers with option grants based on an expired valuation.
During Series A diligence, the investors flagged it. The board required retroactive grants, a revaluation, and legal disclosures. It almost blew the round.
This happens more often than you think.
Real Consequences of Skipping a 409A Valuation
- Stock options taxed immediately
- Lawsuits from disgruntled employees
- Due diligence red flags for future investors
- Delayed M&A timelines
- Bad optics in board meetings
This is why a good valuation isn’t a formality. It’s insurance — and strategy — rolled into one.
409A Valuation vs Investor Valuation: A Final Reality Check
409A keeps you compliant.
Investor valuation helps you raise money.
One protects you. The other promotes you. You need both.
If you’re issuing options, don’t rely on guesses or shortcuts. Hire a pro. Do it right. Get peace of mind now — not regrets later.
Want to shortcut the learning curve? https://kayoneconsulting.com/contact-us/
