This 409A Valuation Exposé is Going Viral… Here’s Why
Employees have long believed that the 409A valuation provides a precise depiction of the true value of the organization that they’re working in. This perception has been ingrained in their minds, thinking that this metric is a reliable indicator of their company’s worth.
The 409A valuation has served as a benchmark, shaping employees’ understanding of the company’s financial standing and overall performance. However, Equitybee Founder and CEO Oren Barzilai recently published a thought leadership article on MSN titled The 409A Valuation Misses the Mark Big Time, which has since gone viral all over social media.
In the post, Oren dropped the facts stating that the 409A Valuation isn’t an accurate representation of how much an organization is actually worth, debunking the myth that it’s a good basis of any company’s true value.
But before we dig down on 409A Valuations loopholes, let’s cover the bases and discuss its true definition.
What is 409A Valuation?
The 409A Valuation is a mandated appraisal by the IRS that independently assesses the fair market value of a private company’s common stock. Essentially, this valuation plays a crucial role in determining the strike price of employees’ stock options, which is the price at which a company can grant those options. Consequently, this valuation greatly impacts one’s ability to become a shareholder within the company.
At first glance, this valuation may appear to be a valuable instrument for understanding the market value of an employee’s options and even gauging the company’s current level of success.
“When companies are growing, they are focused on creating value for their shareholders, or in other words increasing the value of the company and shares,” Oren says. “However, when it comes to appraising the company for the 409A valuation, in order to benefit, retain and attract new employees, they are incentivized to decrease – not increase! – their 409A valuation. Why? Because this valuation will ultimately serve as the strike price for their employee stock options – and it is in the employee’s best interest for this valuation to be lower. The lower the 409A valuation, the less money employees need to shell out when the time comes to exercise their options.”
This bombshell caused a major stir on social media, with users highlighting the importance of correcting this misconception.
“The real value of a company (and, ultimately, the value of its equity) is certainly not determined by the 409A valuation,” he continued. “The true company value is determined by what investors are willing to pay for it.”
If 409A Valuation isn’t reliable, then what is?
Another strong point made was how can startup employees determine the worth of their equity when the 409A valuation is a hit-or-miss. Oren goes on saying that it is paramount to understand the price that investors are willing to shell out for company stock. “The real value is determined by what people are willing to pay for it – and the 409A valuation does not take this into account,” he added.
In fact, this gap served as the catalyst for Equity Value Finder, an Equitybee-powered platform that helps startup employees understand the actual market value of their options. Equipped with this knowledge, users can make informed decisions about their options and gain control over their financial future.
“The Equity Value Finder‘s estimate considers how much investors were recently willing to pay per share – resulting in a more realistic estimate of the fair market value of your stock options. In fact, according to our data on U.S. based startups, the average Equitybee Estimate is 47% higher than the 409A value at the time of the transaction. This is quite a variance between these two valuations – and is key information for startup employees to know in order to make decisions about their financial futures,” Oren concluded.