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When providing stock alternatives or structuring settlement strategies, numerous founders encounter two important-yet often misunderstood-terms: 409A Valuation and Fair Market Value (FMV). At a look, they might seem interchangeable. In practice, they serve various legal, tax, and functional functions. Understanding the distinction between 409A vs FMV is vital for private business, particularly start-ups, that desire to stay compliant and [competitive](https://tancodien.com).
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In this guide, we'll break down:
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- What is a 409A appraisal? +- What is Fair Market Value (FMV)? +- How the IRS views each +- The relationship between 409A and FMV +- Why the distinction matters for equity settlement +- Common misconceptions and errors +- Best practices for startups
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Let's dive in.
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What Is a 409A Valuation?
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A 409A assessment is a formal, independent appraisal utilized to determine the reasonable market price of a personal company's typical stock. It gets its name from Section 409A of the Internal Revenue Code, which governs non-qualified deferred settlement.
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Startups normally use a 409A assessment to set the strike price of stock choices provided to employees. Legally, the strike price need to not be lower than the FMV of the underlying common stock on the grant date. A 409A evaluation assists ensure compliance with this guideline.
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For business utilizing Mantle's cap table management platform, the 409A evaluation can be structured for simple tracking and compliance.
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Key Features of a 409A Valuation:
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- Conducted by a third-party assessment firm +- Required for independently held business providing stock options +- Must be updated every 12 months or after a material occasion (e.g., fundraising, acquisition offer). +- Provides a "safe harbor" to protect companies and employees from IRS penalties
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To learn more on 409A assessments, inspect out our guide.
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What Is Fair Market Price (FMV)?
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Fair Market Price (FMV) is a more comprehensive monetary concept defined by the IRS as:
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" The cost at which the residential or commercial property would change hands between a willing buyer and a ready seller, neither being under any compulsion to buy or to sell and both having affordable knowledge of appropriate realities."
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FMV can be used in several contexts:
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- Sale of company shares or assets. +[- Gifting](https://www.buynzproperty.nz) of equity for estate or tax preparation. +- Purchase of [stock options](https://avcorrealty.com). +- Mergers and acquisitions
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While a 409A evaluation intends to establish FMV for compliance, not all FMV assessments satisfy the requirements needed under 409A.
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409A Valuations vs. Fair Market Value: Key Differences
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Here's how 409A appraisals vs. reasonable market value [compare](https://idealsicily.com) across key locations:
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For a more in-depth look at compliance and valuation threats, check out our post on 409A assessment guide.
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How the IRS Views 409A Valuations vs. FMV
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The IRS uses 409A valuations particularly to manage deferred compensation, such as stock alternatives. If a business issues alternatives with a strike cost listed below FMV without a vlid 409A assessment, the comployee could deal with:
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- Immediate earnings tax on the postponed compensation. +- An extra 20% penalty tax. +- Interest charges on overdue taxes
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Safe Harbor Protection
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A certified 409A valuation provides a safe harbor, shifting the problem of proof to the IRS. To quality:
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- The valuation needs to be carried out by a certified independent [appraiser](https://ivyhouserealty.com). +- It must be less than 12 months old. +- There should have been no product modifications impacting the evaluation.
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FMV, on the other hand, is a general idea used by the IRS in many tax-related scenarios-not simply equity payment. which transfers of residential or commercial property are judged for tax functions.
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Why the Distinction Between 409A and FMV Matters
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Understanding 409A assessments vs. fair market worth is critical for:
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- Issuing equity grants properly. +- Avoiding costly IRS penalties. +- Preparing for audits, due diligence, and acquisitions. +- Planning tax techniques for executives and workers
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A typical error is presuming the FMV equals the current favored stock price. However, favored shares typically bring liquidation preferences and financier securities, suggesting they are worth more than common stock.
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A 409A Valuation accounts for:
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- Capital structure (typical vs. preferred shares). +- Discount for lack of marketability (DLOM). +- Financial performance and market comparables. +- Risk profile and company phase
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Practical Example: VC Round vs. 409A Valuation
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Let's say your start-up raises a Series A round at $10/share for favored stock. That assessment consists of financier rights that common shares do not have.
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A proper 409A appraisal may [evaluate](https://rahumiworld.com) the FMV of typical stock at $2.50/ share, reflecting:
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- Illiquidity of private shares. +- Subordination to favored stock. +- Risk profile for early-stage companies
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Issuing options at $10/share instead of $2.50/ share might:
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- Trigger IRS analysis. +- Deter employees from exercising choices. +- Overstate settlement cost on your books
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When to Update Your 409A Valuation
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To preserve compliance, upgrade your 409A appraisal:
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At least every 12 months. +After any [material](https://misterimobiliare.ro) occasion, such as: - New funding round. +- Acquisition offer. +- Major business pivot. +- Large income modification
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Failing to upgrade your assessment can revoke your safe harbor status and expose the business to tax and legal threat.
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You can find more details on when to upgrade your 409A assessment here.
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Common Mistakes Companies Make
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Relying on Internal FMV Estimates: These normally do not fulfill safe harbor requirements and typically do not have paperwork. +Confusing Preferred and Common Stock Valuation: Valuing typical stock at the same rate as chosen can lead to overvaluation and compliance concerns. +Skipping [Updates](https://rightplace.ie) After Major Events: Material changes like fundraising rounds should trigger an appraisal update. +Granting Options Without a Legitimate 409A: Retroactive rates can lead to charges and gross income for employees. +Best Practices for Managing 409A Valuations and FMV
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- Deal with a trusted third-party appraisal company. +- Schedule appraisal updates annually. +- Update after product occasions. +- Keep comprehensive records of all grants and evaluations. +- Educate workers on how stock choices and FMV work
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Final Thoughts: 409A Valuations vs. Fair Market Value
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While they're closely associated, 409A assessments and price are not interchangeable. FMV is the broader financial idea, while a 409A assessment is a particular, defensible method to identify FMV for providing stock alternatives in private business.
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For start-ups, the best path is to treat 409A [appraisals](https://badak3ikar.com) as a legal and [compliance](https://demo1.xpertixe.com) requirement, and FMV as the foundation of sound equity planning. Understanding and managing both guarantees you stay IRS-compliant, bring in top talent, and maintain openness with financiers and employees.
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Need help with your next 409A valuation or cap table management? See how Mantle can assist improve compliance and equity management for you and your legal group.
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More on 409A appraisals
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409A Valuations for Startups (2025 Guide): What Founders Need to Know. +
409A Valuation Cost Breakdown: What to Expect. +
How to Get ready for a 409A Valuation: A Step-by-Step Checklist. +
+Disclaimer: This article is supplied as basic details to customers and friends of Mantle. It must not be construed as, and does not constitute, monetary, legal or tax guidance on any particular matter, and companies and employees need to always consult their professional advisors, accountants or attorneys as needed when thinking about decisions or actions that may affect your service or individual interests. Mantle does not assume any liability for reliance on the details in this post.
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