Early-stage companies and high-growth businesses commonly backed by venture capitalists often attract and reward employees by issuing restricted stock or stock options to offer an appealing and competitive compensation package.
Compensation in restricted stock or via stock options enables early-stage companies to manage cash flow, attract and incentivize C-level executives and other key employees. The compensation strategy provides a reward for leaders, employees, and independent contractors to offset the inherent risks of working for a start-up. Individuals are incentivized to take a risk with potential sizeable payouts as the company grows and the value of the business increases.
Section 409A of the United State tax code affects companies who offer non-qualified deferred compensation plans including issuing stock options and compensating employees in stock. Compliance with Section 409A requires an objective party to prepare a 409A valuation to determine the value of the stock or exercised stock options to be reported as part of the recipient’s taxable income.
Background on Section 409A
Section 409A was added to the Internal Revenue Code effective January 1, 2005, under The American Jobs Creation Act of 2004. It was enacted partly in response to practices like those of Enron executives, who accelerated payments under their deferred compensation plans to access money before the company went bankrupt. The aim of 409A is to prevent improper deferrals of income for tax benefits.
409A Valuations – Process Matters; Industry Does Not.
Preparing a 409A valuation follows the same process and includes the same components of any detailed and objective business valuation that we develop. The commonly used term ‘409A valuation’ specifically refers to the reason for the business valuation: compliance with Section 409A of the tax code.
We have prepared 409A valuations for a wide variety of industries, and companies, including early stages to high growth; all privately held companies who continue to offer team members, often executive team and management levels, incentives to drive company growth and value.
As we often emphasize in our articles and messaging, industry has no effect on how a business valuation is prepared. We have developed 409A valuations for product and service companies, for companies paying executives in restricted stock, or companies issuing stock options to a broad level of employees multiple times within a year.
Many business valuation firms treat 409A valuations as being unique from business valuations prepared to allocate assets as part of a divorce settlement or for settling an estate or shareholder dispute. We do not. We readily prepare 409A valuations and honestly, enjoy the challenges inherent in developing comprehensive 409A valuations for venture capital-funded companies having complex capital structures including loans, warrants, and convertible loans.
We have a proven track record in developing valuations including 409A valuations that stand up to the highest scrutiny and present the supporting detail as to how and why the business valuation was determined.
Explanation of Timing – Multiple 409A Valuations in a Year
A comprehensive 409A valuation is required for each non-qualified, deferred compensation ‘event’. Events may be a hiring date, a quarterly grant commitment, or company milestone related. Merrimack Business Appraisers is often retained by the company to prepare the 409A valuation per event which can result in multiple valuations being prepared within a year, especially for companies who are on rapid growth trajectory and the number of shareholders and capital structure of the company if often changing.
Read this case study of issuing stock options multiple times in a year.
Conclusion
When you need a 409A valuation, it is important to hire an independent, objective business appraiser with proper appraisal certifications. Given the goal of a 409A valuation prepared is compliance with Section 409A of the tax code, it is important to make an informed business decision to avoid penalties and issues with the tax authorities. Retain a proven business valuation professional whose business is solely focused on business valuation preparation and has a proven track record.
Merrimack Business Appraisers has prepared many 409A valuations for our clients over the years. Our proven processes and track record offer our clients peace of mind that the 409A valuation is objective, defensible, and will stand up to scrutiny.
For leaders in startups and high-growth companies, peace of mind and confidence that they are compliant with tax authorities are highly valued.
When Values Matters.
