409 Valuations in Venture Capital
A few months ago, I wrote a blog on the good old days of sweat equity pricing. The option exercise price was supposed to be set at the fair market value of the common stock on the date the option was granted. The “technical” problem of figuring out fair market value was as much ritual as science: the process typically culminated in a boilerplate board resolution that implied a timely, exhaustive, good faith effort by the board – that in reality was mostly driven by rules of thumb. Among those rules, the “common is worth 1/10th the preferred at the time of a first round venture financing” was one of the most popular. Life was more or less good for founders, employees and investors alike. If you stuck to the rules of thumb and backed it up with the appropriate boilerplate, the IRS generally looked the other way.
And then came 2004, and Internal Revenue Code Section 409A, and the game was up.
Recently, Alex Klingelberger of Whitehawk Advisory passed on a valuable presentation to me that covers 409A‐related frequently asked questions, the nature and effect of limitations placed on valuations by valuation specialist review groups, and an empirical study of results for valuations conducted during the past five years. I am, in turn, passing it along to our Venture Best blog readers, as I have found the presentation to be quite informative and useful to entrepreneurs and several of our clients.
Click here to view Klingelberger’s presentation on 409 Valuations.