A client recently obtained a 409A valuation to issue equity to a new co-founder. The valuation for their pre-revenue startup, which had raised less than $400k, came in much higher than the nominal value they had expected.
409A valuations are highly dependent on the firm's methodology. The IRS doesn’t prescribe a specific approach, leaving valuation firms with a lot of discretion.
Pulley often ties valuations for pre-revenue startups to the total invested capital, which can result in a higher FMV. Personally, I don’t believe a company’s value should simply equal the amount it has raised. We all know that number can be meaningless—after all, a company could go out of business in a month.
Carta, on the other hand, factors in the company’s stage, market conditions, and comparables. I agree with their approach, which can lead to lower FMVs, however, we’ve seen cases where Carta assigns valuations at par value (!) for startups with revenue that raised over $800k through convertibles. I don’t agree with this approach either and often recommend founders opt for a higher, more defensible valuation.
If your 409A feels out of line, it’s probably not your fault. Different firms use different methodologies. The only real issue arises if you provided overly optimistic projections to the valuation firm. Otherwise, the valuation reflects the firm’s unique interpretation of IRS guidelines.
1. Reject the valuation
If it’s still in draft before it gets finalized, you can reject it and try a different provider. Keep in mind that even if you don’t get better results, you’ll likely spend another $3k–4k on the process.
2. Accept the valuation
If you decide to move forward, we can help structure the consideration as a loan or issue equity grants as stock options. It’s not ideal, but sometimes you have to make the best of the situation.
Here is more information on the importance of 409A valuations, when they are required, when they’re optional, and the factors that influence the valuation you receive.
