Investors Don’t Care about Your 409A Valuation
Startup founders should not use the 409A valuation to determine the company’s value for investors. A 409A valuation is designed for tax compliance and not for determining a company’s enterprise value. The methodologies permitted by the IRS for 409A valuations differ from the methodologies used by professional business valuation firms when valuing startups.
For one, 409A valuations tend to be low since they aim to minimize tax liability for employees exercising stock options. Investors may value a company much higher than what a 409A report reflects.
In addition, common 409A valuation methodologies are generally not suitable for startups. These include:
Guideline Company Method: using revenue from public company comparables.
M&A Method: using the sale price of an acquisition or merger of comparable companies.
Past Fundraising: benchmarking to the company’s last funding round using Black-Sholes.
Income Approach: using present value of future income.
Asset Approach: an asset approach to determine the value of what the company has created.
To determine valuation for fundraising, startups should consider the following methodologies to attract investors and negotiate funding terms.
Market-Driven Valuation: using the amount investors are willing to pay in a funding round.
Comparable Company Analysis: looking at similar startups that recently raised capital.
Discounted Cash Flow Analysis: applying future cash flow projections.
Venture Capital Method: estimating future exit value and discounting for risk.
Startups should rely on their internal finance team or engage an outside accounting or valuation firm to develop a substantiated enterprise value based on the professional methodologies above.
