A 409A valuation is an independent appraisal that determines the fair market value (FMV) of a private company’s common stock, as required by Section 409A of the U.S. Internal Revenue Code. It is most commonly used by private companies that issue stock options or equity-based compensation to employees, ensuring those options are granted at or above fair market value to comply with IRS rules.
While often associated with tech startups, 409A valuations also apply to real estate businesses structured as private corporations, particularly when they grant equity or stock options to employees, partners, or investors.
Key Points about 409A Valuation
- Purpose: Establishes a defensible strike price for stock options or deferred compensation, protecting against IRS penalties.
- Applicability: Required for private companies, including real estate holding companies, development firms, or REIT-like entities issuing equity incentives.
- Frequency: Must be updated at least every 12 months or after a material event such as a fundraising round, merger, or acquisition.
- Safe Harbor: Using an independent, qualified third-party appraiser provides safe harbor status, reducing the risk of IRS challenges.
- Methods Used: Income, market, or asset-based approaches are applied. For real estate firms, appraisers may emphasize property-level cash flows, asset valuations, and comparable sales.
Real Estate Context
In real estate, 409A valuations are relevant when:
- A portfolio holding company issues stock options tied to underlying property assets.
- Developers or sponsors grant equity incentives to employees or partners.
- Firms need valuations for tax planning, M&A transactions, fundraising, or internal accounting.
- Real estate portfolios require discounts for lack of marketability (DLOM), since shares in private companies are less liquid than public stock.
