409A Valuation vs Fair Market Value: What Every Founder Must Know

Your investors say your company is worth $50 million. Your 409A says common stock is worth $1.20 per share. Your employees are confused. This blog explains why both numbers are correct and why the difference is not a problem to fix but a structure to understand.

What does fair market value mean under Section 409A?

Fair market value (“FMV”) is a legal concept with a precise definition under the IRS regulations governing §409A. It is not the same as what your last investor paid, what your board thinks the company is worth, or what a financial model might project. The IRS defines FMV as the price at which property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of the relevant facts.

Three elements of that definition matter for founders. First, it is a hypothetical transaction, no actual buyer or seller needs to exist. Second, it assumes neither party is under pressure, there is no distressed sale, no strategic urgency, no competitive auction dynamic. Third, it assumes equal information, both parties know what the company is and what the shares represent.

Under §409A specifically, the FMV being established is the value of a single share of common stock in a private company, not the enterprise value, not the preferred share price, and not the value a strategic acquirer might pay for control. It is a narrow, specific, legally defined number that serves one purpose: setting the floor below which employee stock options cannot be struck.

FMV is a legal concept, not an accounting one. While ASC 820 (the accounting standard governing fair value measurement) uses similar language, §409A FMV and ASC 820 fair value are distinct concepts applied in different contexts. Your auditors and your appraiser may both talk about "fair value" but they are not always talking about the same thing. This distinction is covered in more detail below.

Why your 409A FMV is lower than your investor valuation

This is the question founders ask most frequently, and it is entirely reasonable. If investors just valued the company’s shares at a higher number, why does the 409A say common stock is worth a fraction of that?

The answer is that investors did not buy common stock. They bought preferred stock, and preferred stock is a meaningfully different instrument from common stock in ways that have real economic consequences.

Preferred stock carries rights that common stock does not 

When a venture investor puts $12 million into a company at a $50 million post-money valuation, they receive preferred shares. Those preferred shares typically carry a liquidation preference, meaning that in an exit, the investor recovers the $12 million before common shareholders receive any proceeds. In many structures, preferred shareholders may also share in the remaining proceeds with common shareholders after receiving their preference.

This means that at a modest exit the preferred shareholders may receive most or all of the proceeds, leaving little or nothing for common shareholders. Only in a large enough exit does common stock participate meaningfully in the upside. The gap between the preferred price and the common FMV reflects this economic reality. Common stock is genuinely worth less than preferred stock at the same company, because it is a different and structurally subordinate instrument.

The investor valuation is not the company's "worth" for FMV purposes

The $50 million post-money valuation is a negotiated number reflecting the price at which a specific investor agreed to buy a specific instrument at a specific point in time. It reflects the investor's return expectations, competitive deal dynamics, and the particular terms negotiated. It is not a neutral, independent assessment of what a share of common stock is worth to a hypothetical arm's length buyer, the 409A is that neutral, independent assessment.

The common-to-preferred ratio. The ratio of the 409A FMV to the preferred share price, sometimes called the common-to-preferred ratio, reflects the degree of economic subordination of common stock at a given stage. At seed stage this ratio is typically lower, reflecting higher uncertainty and more subordination. As the company grows and approaches a liquidity event, the ratio tends to increase as the preferred preferences become a smaller proportion of total enterprise value. For more on how this evolves across stages, see: 409A Valuations Across Funding Stages.

409A FMV vs Post-money Valuation vs ASC 820

Founders regularly encounter multiple different "valuations" of their company in different contexts, from investor term sheets to financial audits to board discussions. These are not the same number and conflating them creates confusion. Here is a plain-language guide to the four most common valuation concepts a founder will encounter and how they differ from §409A FMV:

409A context

The independently determined fair market value of a single share of common stock, used to set the strike price for employee stock options. Produced by a qualified independent appraiser. A legal safe harbor concept under IRC §409A

Financing context

The negotiated enterprise value implied by a financing round, the price per preferred share multiplied by the fully diluted share count. Reflects the terms of a specific transaction, not the FMV of common stock. Always higher than the §409A FMV for the same company at the same time.

Accounting context

The accounting standard governing fair value measurement in financial statements. Used for stock-based compensation expense calculations under ASC 718. Similar language to §409A FMV but a distinct concept. Your auditors apply ASC 820, your appraiser produces the §409A FMV, and the two should be consistent but are not identical.

Board context 

An informal value assigned by the board, sometimes used for internal planning or early-stage option pricing before a formal 409A is obtained. Does not meet the qualified independent appraiser standard required for the §409A safe harbor. Using a board determination in place of a 409A exposes both the company and option holders to IRS challenge.

Why FMV is determined at the grant date, not at exercise or sale

The §409A compliance obligation is anchored to a specific moment: the grant date. The grant date is the date on which the board approves the option grant and sets the strike price. The FMV established by the 409A must reflect the value of common stock on that date, not a future date, not a projected date, and not the date the employee eventually exercises the option or sells the underlying shares.

This timing principle has two important practical consequences. First, the 409A must be contemporaneous, it must be obtained before or at the time of the grant, not retroactively justified after the fact. An appraisal produced six months after a grant cycle, even if methodologically sound, is not a contemporaneous appraisal and does not provide a safe harbor for those grants.

Second, the FMV will change over time as the company's circumstances change and the 409A for a grant made in January is not the same as the FMV applicable to a grant made in December, even if the same appraiser is used and the same methodology is applied. Each grant cycle requires a current, valid appraisal reflecting conditions at the time of that grant.

Retroactive appraisals do not create a safe harbor. This is one of the most consequential timing errors in startup equity practice. A company that grants options in January and obtains the 409A in March has not protected those January grants. The safe harbor requires a contemporaneous appraisal, not a subsequent one. 

What moves FMV over time

The §409A FMV of common stock is not static. It moves as the company's circumstances evolve. The primary drivers of FMV movement are:

• New financing rounds. Each priced round creates a new enterprise value anchor that changes both the OPM allocation and the implied value of common stock. A Series B at a significantly higher valuation than the Series A will produce a meaningfully higher common stock FMV in the post-B 409A.
• Business performance. Material improvements in revenue, retention, or margins change the DCF output and the comparable company multiples applicable to the business, both of which feed into the enterprise value and therefore the common stock FMV.
• Public market conditions. Because the market comparable approach uses publicly traded peer companies, movements in public market multiples flow directly into the private 409A FMV, even when the company's own performance has not changed.
• Approaching a liquidity event. As the company moves closer to a potential exit (through an IPO or M&A), the DLOM applied to common stock narrows and the probability-weighted value of common stock increases, even without a change in the underlying enterprise value.

For a deeper look at how FMV changes across funding stages—and why valuation methodologies evolve as a company grows—see: 409A Valuations Across Funding Stages: How Methodology, FMV, and Timing Evolve As You Grow.

Why is a lower FMV not bad news for employees

Founders sometimes feel apologetic when presenting new employees with a strike price that is significantly below the investor price as though the lower number signals a less valuable company or a worse deal for the employee. The opposite is closer to the truth.

A strike price set on a defensible, appropriately conservative 409A FMV is a lower threshold that employees need the company to exceed before their options are in the money. The lower the strike price relative to the eventual exit value, the larger the spread and the more valuable the option. An option struck at $1.20 in a company that exits at $15.00 per share produces a $13.80 gain per option. An option struck at $2.40 in the same company produces a gain of $12.60. The employee with the lower strike price is better off.

The 409A FMV reflects the genuine economic reality of what a share of common stock is worth today, not what it might be worth at exit, and not the price an investor paid for a structurally superior instrument. Communicating this clearly to employees, particularly new hires who are comparing their strike price to the preferred price in the press release, is one of the most valuable things a founder can do to maintain trust in the equity compensation programme.

The strike price is a starting line, not a ceiling. Employees who understand that their strike price is the floor below which they receive nothing (and that everything above it is their gain) will appreciate a lower strike price for exactly what it is: a better deal, not a worse one.

Key Takeaways

• FMV under §409A is a legally defined concept, the price between a willing buyer and seller with equal information and no compulsion
• The 409A FMV of common stock is always lower than the investor preferred price, preferred shares carry liquidation preferences that common shares do not
• The post-money investor valuation, 409A FMV, ASC 820 fair value, and board-determined value are four distinct concepts that are frequently confused
• FMV must be established at the grant date, retroactive appraisals do not create a safe harbor
• FMV increases as the company grows, raises capital, and approaches a liquidity event
• A lower strike price is better for employees, it represents a lower threshold before options are in the money

Related Reading in This Series

• The Complete Guide to 409A Valuations for Startups
• Who Gets Paid First? Understanding the Liquidation Waterfall
• Splitting The Pie: How Equity Allocation Methods Determine What Your Common Stock Is Really Worth
• The Invisible Haircut: Why Your Common Stock Is Worth Less Than the Allocation Model Says

This article is part of a series on 409A valuation and is intended for general informational purposes only. It does not constitute legal, tax, or financial advice. The distinction between §409A fair market value and other valuation concepts described here is a general framework. Its application to any specific company, share class, or transaction is fact-specific and requires professional judgment. Companies should obtain qualified legal counsel and a credentialed independent appraiser before making equity compensation or valuation decisions. This article does not create an attorney-client or appraiser-client relationship.