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When issuing stock alternatives or structuring compensation strategies, many creators experience two important-yet typically misunderstood-terms: 409A Valuation and Fair Market Price (FMV). At a glance, they may appear interchangeable. In practice, they serve different legal, tax, and operational functions. Understanding the distinction in between 409A vs FMV is essential for personal companies, particularly start-ups, that wish to stay 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 in between 409A and FMV
Why the difference matters for equity settlement
Common mistaken beliefs 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 figure out the fair market price of a private company's typical stock. It gets its name from Section 409A of the Internal Revenue Code, which governs non-qualified postponed payment.

Startups typically utilize a 409A valuation to set the strike rate of stock options provided to employees. Legally, the strike rate should not be lower than the FMV of the underlying typical stock on the grant date. A 409A appraisal helps make sure compliance with this rule.

For business using Mantle's cap table management platform, the 409A assessment can be structured for simple tracking and compliance.

Key Features of a 409A Valuation:

- Conducted by a third-party valuation firm
Required for independently held business providing stock options
Must be updated every 12 months or after a material occasion (e.g., fundraising, acquisition deal).
Provides a "safe harbor" to secure business and workers from IRS charges

For additional information on 409A valuations, inspect out our guide.

What Is Fair Market Price (FMV)?

Fair Market Price (FMV) is a wider monetary idea specified by the IRS as:

" The rate at which the residential or commercial property would change hands between a ready buyer and a willing seller, neither being under any compulsion to purchase or to sell and both having reasonable knowledge of relevant facts."

FMV can be used in several contexts:

- Sale of company shares or possessions.
Gifting of equity for estate or tax planning.
Purchase of stock options.
Mergers and acquisitions

While a 409A evaluation aims to establish 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 assessments vs. reasonable market price compare across crucial areas:

For a more detailed look at compliance and assessment dangers, have a look at our post on 409A valuation guide.

How the IRS Views 409A Valuations vs. FMV

The IRS uses 409A assessments particularly to regulate deferred compensation, such as stock alternatives. If a company problems options with a strike price below FMV without a vlid 409A appraisal, the comployee could deal with:

- Immediate income tax on the delayed settlement.
An additional 20% charge tax.
Interest charges on overdue taxes

Safe Harbor Protection

A compliant 409A appraisal provides a safe harbor, shifting the burden of proof to the IRS. To quality:

- The assessment must be carried out by a certified independent appraiser.
It needs to be less than 12 months old.
There need to have been no material changes impacting the assessment.

FMV, on the other hand, is a general concept utilized by the IRS in lots of tax-related scenarios-not just equity compensation. which transfers of residential or commercial property are evaluated for tax functions.

Why the Distinction Between 409A and FMV Matters

Understanding 409A evaluations vs. reasonable market value is important for:

- Issuing equity grants correctly.
Avoiding pricey IRS charges.
Preparing for audits, due diligence, and acquisitions.
Planning tax strategies for executives and workers

A typical mistake is assuming the FMV equates to the current favored stock price. However, favored shares often carry liquidation preferences and financier protections, meaning they are worth more than typical stock.

A 409A Valuation accounts for:

- Capital structure (typical vs. favored shares).
Discount for lack of marketability (DLOM).
Financial performance and market comparables.
Risk profile and business stage

Practical Example: VC Round vs. 409A Valuation

Let's state your startup raises a Series A round at $10/share for favored stock. That valuation consists of financier rights that typical shares don't have.

A correct 409A assessment may evaluate the FMV of typical stock at $2.50/ share, reflecting:

- Illiquidity of personal shares.
Subordination to favored stock.
Risk profile for early-stage business

Issuing choices at $10/share rather of $2.50/ share could:

- Trigger IRS analysis.
Deter staff members from exercising alternatives.
Overstate settlement expense on your books

When to Update Your 409A Valuation

To preserve compliance, update your 409A valuation:

At least every 12 months. After any material occasion, such as: - New funding round.
Acquisition offer. - Major company pivot.
Large profits change

Failing to upgrade your appraisal can revoke your safe harbor status and expose the business to tax and legal danger.

You can find more information on when to upgrade your 409A evaluation here.

Common Mistakes Companies Make

Relying on Internal FMV Estimates: These generally don't satisfy safe harbor requirements and typically lack paperwork. Confusing Preferred and Common Stock Valuation: Valuing common stock at the very same rate as chosen can lead to overvaluation and compliance concerns. Skipping Updates After Major Events: Material changes like fundraising rounds should activate an evaluation update. Granting Options Without a Legitimate 409A: Retroactive pricing can result in charges and taxable income for workers. Best Practices for Managing 409A Valuations and FMV

- Deal with a respectable third-party assessment firm.
Schedule assessment updates each year.
Update after product occasions.
Keep of all grants and valuations.
Educate employees on how stock choices and FMV work

Final Thoughts: 409A Valuations vs. Fair Market Price

While they're carefully associated, 409A evaluations and fair market value are not interchangeable. FMV is the broader monetary idea, while a 409A evaluation is a specific, defensible approach to figure out FMV for releasing stock options in personal companies.

For startups, the safest path is to deal with 409A assessments as a legal and compliance requirement, and FMV as the foundation of sound equity preparation. Understanding and handling both ensures you remain IRS-compliant, draw in leading skill, and maintain openness with investors and employees.

Need help with your next 409A valuation or cap table management? See how Mantle can help streamline compliance and equity management for you and your legal group.

More on 409A valuations

409A Valuations for Startups (2025 Guide): What Founders Need to Know.
409A Valuation Cost Breakdown: What to Expect.
How to Get ready for a 409A Valuation: A Detailed Checklist.
Disclaimer: This post is provided as basic info to customers and friends of Mantle. It needs to not be interpreted as, and does not constitute, monetary, legal or tax advice on any particular matter, and companies and workers ought to constantly consult their professional advisors, accounting professionals or lawyers as required when considering decisions or actions that may affect your business or individual interests. Mantle does not assume any liability for reliance on the info in this blog site post.