409A Valuations… What’s the Issue?

By Jeff Faust, CVA, Director of Valuation Services
ASL Business Valuation Services

First, a little background, 409A is an IRS Code section that requires companies to grant stock options at Fair Market Value (FMV), meaning no discounts anymore. In order for a company to prove they granted stock options at FMV, they’ll need to follow the valuation rules surrounding 409A.

So what’s the issue?
Since this is now a requirement for companies, a lot of valuation firms and software tools have emerged to provide 409A Valuations to capitalize on the “annuity revenue” from this service. The problem now is that there is too much competition, resulting in dropping prices and low quality valuations. Companies should be aware that most “cheap valuations” do not follow the specific rules and will not pass an audit from the Big 4, the IRS or even a local/regional auditor.

The risk
Should the valuation not follow the rules and get “thrown out”, the company will need to get another one which takes added time and costs and even worse, the results may be materially different than the original valuation which would mean correcting historical option grants. This could be a bigger disaster if this was discovered during due diligence by a large acquirer. Unfortunately, poor quality 409A Valuations have led to large deals falling through.

Companies think they are saving a little money and don’t understand the risks they are taking by getting a valuation that does not follow the specific rules set by the AICPA. Quality matters. Here at ASL, we have created special tiered pricing based on stage and complexity of a company to keep costs down but quality up.

What’s next
If your company has granted options, were they granted pursuant to a quality 409A Valuation? Please reach out to ASL’s Director of Valuation Services, Jeff Faust (jfaust@aslcpa.com or 408-377-8700 x232), and he would be happy to discuss the above or your valuation related questions.