Your 409A valuation provider will ask you for your selected valuation date and there are some good rules of thumb to apply. By asking some simple questions you can home in on the right valuation date for your company and your specific set of circumstances.
The catalyst for a 409A valuation is the need to issue stock options. The IRS considers stock options deferred compensation and as such they must be issued at fair market value to avoid any tax issues. If you don’t need to issue stock options right away, then you don’t need a 409A valuation right away. The valuation you get will be good for a full year, barring any material events during that year (e.g. equity capital raise or material change in the prospects of the business). So you may as well maximize that year by not getting the valuation until you need to issue options.
Once you do indeed need the valuation you should ask what is the most recent period for which you can provide financials. If you close your books monthly then just go with your most recent month close as the valuation date. If quarterly, then the most recent quarter close should be the valuation date. If annually, then we should introduce you to some great Accounting/Finance resources because you need better data to run your business.
Another question is if you are funding the business with venture investments then when did you close your most recent funding round? Frequently the valuation date will just coincide with the close of that round as you will have all the information your valuation firm needs as of that date. The upside of this approach is it makes the valuation very straightforward. The downside of this approach is it makes the valuation very straightforward. Did you see what I did there? The point being that imputing the value of common stock based on recently priced preferred stock is relatively formulaic and leaves less room for judgment and assumptions. That can be great and is certainly our preference as valuation firms. But occasionally we will get clients that want the valuation firm to see a different story than was recently told to investors. If you do the valuation right on the heels of the round, then that is a tough sell – for the valuation firm and your auditors (or an IRS auditor). But the more time that has passed since a funding round, the more chance that things may have legitimately changed versus the thesis into which investors injected their dollars.
We regularly get questions from clients regarding historical valuations. If you are considering getting a valuation for a point in time more than a quarter in the rear view mirror, then legal counsel should be involved and approve of the decision to do a historical valuation. Generally they’ll base their advice on how formal and firm (in writing) grant commitments were. Some will advise against it entirely citing an “abundance of caution”. We are not here to provide legal or tax advice, but we can do a valuation for any point in time as long as your legal and tax counsel are on board. You should be aware that we have the benefit of hind sight, which will inform the conclusion.
In doing a historical valuation the valuation firm is trying to “re-create” the world back then, so historical files such as board presentations with projections are much more credible and reliable than management-created a model today for what they thought the world looked like back then. The more documentation from that point in time that you can provide, the more defensible the valuation.