409A Valuation Vs. Fair Market Value FMV : What s The Difference
When issuing stock choices or structuring payment plans, lots of creators come across two important-yet often misunderstood-terms: 409A Valuation and Fair Market Value (FMV). At a glimpse, they may seem interchangeable. In practice, they serve various legal, tax, and operational functions. Understanding the difference in between 409A vs FMV is important for private companies, especially start-ups, that wish to remain certified and competitive.
In this guide, we'll break down:
- What is a 409A valuation?
- What is Fair Market Price (FMV)?
- How the IRS views each
- The relationship between 409A and FMV
- Why the distinction matters for equity settlement
- Common misunderstandings and errors
- Best practices for startups
Let's dive in.
What Is a 409A Valuation?
A 409A evaluation is an official, independent appraisal used to identify the reasonable market value of a personal business's common stock. It gets its name from Section 409A of the Internal Revenue Code, which governs non-qualified postponed compensation.
Startups generally use a 409A appraisal to set the strike rate of stock choices issued to staff members. Legally, the strike rate should not be lower than the FMV of the underlying common stock on the grant date. A 409A assessment assists guarantee compliance with this rule.
For business utilizing Mantle's cap table management platform, the 409A valuation can be streamlined for easy tracking and compliance.
Key Features of a 409A Valuation:
- Conducted by a third-party assessment firm
- Required for privately held business issuing stock options
- Must be updated every 12 months or after a material event (e.g., fundraising, acquisition offer).
- Provides a "safe harbor" to protect companies and staff members from IRS charges
To learn more on 409A appraisals, examine out our guide.
What Is Fair Market Price (FMV)?
Fair Market Price (FMV) is a more comprehensive monetary concept specified by the IRS as:
" The rate at which the residential or commercial property would change hands between a prepared purchaser and a willing seller, neither being under any compulsion to buy or to offer and both having sensible knowledge of relevant truths."
FMV can be used in numerous contexts:
- Sale of company shares or properties.
- Gifting of equity for estate or tax preparation.
- Purchase of stock alternatives.
- Mergers and acquisitions
While a 409A valuation intends to develop FMV for compliance, not all FMV assessments satisfy the standards required under 409A.
409A Valuations vs. Fair Market Price: Key Differences
Here's how 409A valuations vs. fair market worth compare across essential areas:
For a more comprehensive take a look at compliance and appraisal dangers, check out our post on 409A evaluation guide.
How the IRS Views 409A Valuations vs. FMV
The IRS utilizes 409A appraisals particularly to control deferred compensation, such as stock choices. If a company concerns choices with a strike rate listed below FMV without a vlid 409A appraisal, the comployee might face:
- Immediate earnings tax on the postponed compensation.
- An additional 20% penalty tax.
- Interest charges on unsettled taxes
Safe Harbor Protection
A certified 409A assessment offers a safe harbor, moving the problem of proof to the IRS. To quality:
- The evaluation should be carried out by a certified independent appraiser.
- It must be less than 12 months old.
- There should have been no product changes affecting the assessment.
FMV, on the other hand, is a general principle used by the IRS in lots of tax-related scenarios-not simply equity payment. which transfers of residential or commercial property are judged for tax purposes.
Why the Distinction Between 409A and FMV Matters
Understanding 409A valuations vs. reasonable market price is critical for:
- Issuing equity grants properly.
- Avoiding expensive IRS charges.
- Getting ready for audits, due diligence, and acquisitions.
- Planning tax techniques for executives and workers
A typical error is presuming the FMV equates to the current preferred stock cost. However, favored shares typically carry liquidation preferences and investor protections, indicating they are worth more than common stock.
A 409A Valuation accounts for:
- Capital structure (typical vs. preferred shares).
- Discount for absence of marketability (DLOM).
- Financial efficiency and market comparables.
- Risk profile and service phase
Practical Example: VC Round vs. 409A Valuation
Let's say your start-up raises a Series A round at $10/share for preferred stock. That evaluation includes financier rights that typical shares do not have.
A correct 409A might assess the FMV of common stock at $2.50/ share, showing:
- Illiquidity of private shares.
- Subordination to preferred stock.
- Risk profile for early-stage business
Issuing options at $10/share rather of $2.50/ share might:
- Trigger IRS scrutiny.
- Deter workers from exercising alternatives.
- Overstate compensation expense on your books
When to Update Your 409A Valuation
To keep compliance, upgrade your 409A valuation:
A minimum of every 12 months.
After any product occasion, such as: - New financing round.
- Acquisition offer.
- Major service pivot.
- Large profits modification
Failing to upgrade your assessment can invalidate your safe harbor status and expose the company to tax and legal threat.
You can find more information on when to update your 409A appraisal here.
Common Mistakes Companies Make
Depending On Internal FMV Estimates: These typically do not meet safe harbor standards and often lack documents.
Confusing Preferred and Common Stock Valuation: Valuing typical stock at the same rate as chosen can result in overvaluation and compliance issues.
Skipping Updates After Major Events: Material changes like fundraising rounds need to activate an evaluation upgrade.
Granting Options Without a Valid 409A: Retroactive rates can result in penalties and taxable earnings for staff members.
Best Practices for Managing 409A Valuations and FMV
- Deal with a reliable third-party assessment company.
- Schedule evaluation updates every year.
- Update after material occasions.
- Keep in-depth records of all grants and appraisals.
- Educate workers on how stock alternatives and FMV work
Final Thoughts: 409A Valuations vs. Fair Market Price
While they're carefully related, 409A evaluations and fair market price are not interchangeable. FMV is the more comprehensive financial principle, while a 409A appraisal is a particular, defensible technique to figure out FMV for issuing stock alternatives in private companies.
For startups, the best route is to treat 409A appraisals as a legal and compliance requirement, and FMV as the foundation of sound equity preparation. Understanding and managing both ensures you remain IRS-compliant, attract top talent, and maintain transparency with investors and employees.
Need aid 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.
More on 409A assessments
409A Valuations for Startups (2025 Guide): What Founders Need to Know.
409A Valuation Cost Breakdown: What to Expect.
How to Prepare for a 409A Valuation: A Step-by-Step Checklist.
Disclaimer: This post is provided as general info to customers and pals of Mantle. It ought to not be interpreted as, and does not constitute, monetary, legal or tax guidance on any specific matter, and companies and staff members should always consult their professional advisors, accounting professionals or lawyers as required when thinking about choices or actions that might impact your company or individual interests. Mantle does not presume any liability for dependence on the info in this post.