When releasing stock options or structuring compensation strategies, numerous founders come across two important-yet frequently misunderstood-terms: 409A Valuation and Fair Market Price (FMV). At a look, they might appear interchangeable. In practice, they serve different legal, tax, and functional functions. Understanding the distinction between 409A vs FMV is essential for private companies, particularly startups, that wish to stay certified and competitive.

In this guide, we'll break down:

- What is a 409A assessment?

• What is Fair Market Price (FMV)?
• How the IRS views each
• The relationship between 409A and FMV
• Why the distinction matters for equity compensation
• Common misconceptions and mistakes
• Best practices for startups
  
  Let's dive in.
  
  What Is a 409A Valuation?
  
  A 409A evaluation is an official, independent appraisal utilized to identify the fair market worth of a personal business's typical stock. It gets its name from Section 409A of the Internal Revenue Code, which governs non-qualified postponed payment.
  
  Startups usually utilize a 409A evaluation to set the strike rate 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 valuation assists ensure compliance with this guideline.
  
  For companies using Mantle's cap table management platform, the 409A appraisal can be streamlined for and compliance.
  
  Key Features of a 409A Valuation:
  
  - Conducted by a third-party evaluation firm
• Required for privately held companies releasing stock alternatives
• Must be updated every 12 months or after a material event (e.g., fundraising, acquisition offer).
• Provides a "safe harbor" to safeguard business and workers from IRS charges
  
  For more info on 409A evaluations, take a look at our guide.
  
  What Is Fair Market Value (FMV)?
  
  Fair Market Value (FMV) is a wider financial principle defined by the IRS as:
  
  " The price at which the residential or commercial property would change hands in between a ready buyer and a ready seller, neither being under any obsession to buy or to sell and both having affordable knowledge of pertinent facts."
  
  FMV can be utilized in multiple contexts:
  
  - Sale of business shares or properties.
• Gifting of equity for estate or tax planning.
• Purchase of stock alternatives.
• Mergers and acquisitions
  
  While a 409A valuation aims to develop FMV for compliance, not all FMV evaluations satisfy the standards needed under 409A.
  
  409A Valuations vs. Fair Market Value: Key Differences
  
  Here's how 409A assessments vs. reasonable market price compare across key areas:
  
  For a more in-depth take a look at compliance and appraisal dangers, take a look at our post on 409A evaluation guide.
  
  How the IRS Views 409A Valuations vs. FMV
  
  The IRS uses 409A appraisals specifically to regulate deferred settlement, such as stock choices. If a business problems options with a strike cost below FMV without a vlid 409A evaluation, the comployee might deal with:
  
  - Immediate earnings tax on the postponed settlement.
• An extra 20% charge tax.
• Interest charges on unsettled taxes
  
  Safe Harbor Protection
  
  A compliant 409A valuation offers a safe harbor, moving the burden of evidence to the IRS. To quality:
  
  - The assessment needs to be carried out by a certified independent appraiser.
• It must be less than 12 months old.
• There need to have been no product modifications impacting the assessment.
  
  FMV, on the other hand, is a basic principle used by the IRS in lots of tax-related scenarios-not just equity settlement. which transfers of residential or commercial property are judged for tax purposes.
  
  Why the Distinction Between 409A and FMV Matters
  
  Understanding 409A assessments vs. fair market value is vital for:
  
  - Issuing equity grants properly.
• Avoiding expensive IRS penalties.
• Preparing for audits, due diligence, and acquisitions.
• Planning tax methods for executives and employees
  
  A typical error is assuming the FMV equals the most recent favored stock price. However, preferred shares often carry liquidation preferences and financier protections, suggesting they deserve more than common stock.
  
  A 409A Valuation accounts for:
  
  - Capital structure (common vs. preferred shares).
• Discount for absence of marketability (DLOM).
• Financial performance and market comparables.
• Risk profile and business stage
  
  Practical Example: VC Round vs. 409A Valuation
  
  Let's state your start-up raises a Series A round at $10/share for favored stock. That appraisal includes investor rights that common shares don't have.
  
  An appropriate 409A appraisal might assess the FMV of typical stock at $2.50/ share, showing:
  
  - Illiquidity of personal shares.
• Subordination to favored stock.
• Risk profile for early-stage business
  
  Issuing choices at $10/share rather of $2.50/ share might:
  
  - Trigger IRS analysis.
• Deter employees from exercising alternatives.
• Overstate compensation cost on your books
  
  When to Update Your 409A Valuation
  
  To maintain compliance, update your 409A valuation:
  
  A minimum of every 12 months. After any product occasion, such as: - New financing round.
• Acquisition offer.
• Major organization pivot.
• Large income change
  
  Failing to upgrade your assessment can invalidate your safe harbor status and expose the company to tax and legal risk.
  
  You can discover more details on when to update your 409A appraisal here.
  
  Common Mistakes Companies Make
  
  Relying on Internal FMV Estimates: These usually don't meet safe harbor requirements and typically do not have paperwork. Confusing Preferred and Common Stock Valuation: Valuing common stock at the same cost as chosen can lead to overvaluation and compliance problems. Skipping Updates After Major Events: Material modifications like fundraising rounds must trigger an evaluation update. Granting Options Without a Legitimate 409A: Retroactive prices can lead to penalties and taxable earnings for employees. Best Practices for Managing 409A Valuations and FMV
  
  - Work with a respectable third-party assessment firm.
• Schedule assessment updates yearly.
• Update after material events.
• Keep detailed records of all grants and valuations.
• Educate staff members on how stock alternatives and FMV work
  
  Final Thoughts: 409A Valuations vs. Fair Market Value
  
  While they're closely related, 409A evaluations and reasonable market worth are not interchangeable. FMV is the wider financial idea, while a 409A evaluation is a particular, defensible approach to figure out FMV for providing stock alternatives in personal companies.
  
  For startups, the best route is to treat 409A evaluations as a legal and compliance requirement, and FMV as the foundation of sound equity preparation. Understanding and managing both ensures you stay IRS-compliant, draw in leading talent, and keep openness with investors and employees.
  
  Need aid with your next 409A assessment or cap table management? See how Mantle can assist improve compliance and equity management for you and your legal team.
  
  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 article is supplied as basic info to clients and friends of Mantle. It should not be interpreted as, and does not make up, monetary, legal or tax suggestions on any particular matter, and employers and workers must constantly consult their expert consultants, accounting professionals or lawyers as needed when thinking about choices or actions that might affect your business or individual interests. Mantle does not presume any liability for reliance on the information in this post.
anaheimhousing.com