When a 409A Isn't Enough: Choosing the Right Valuation Standard

Every year, founders bring us a 409A report and ask us to confirm it as the value of their business. Every year, we explain that the number in a 409A report is not the value of their business — it is the value of their common stock for the specific tax purpose of issuing employee options at strike. For any other use, the number is likely wrong.

The reason is not sloppy analysts. It is that different situations require different valuation standards, and each standard produces a different number for the same business on the same day. Choosing the right standard is not a formality. It is the first substantive decision in any valuation engagement.

Fair Market Value (FMV) is the standard for estate and gift tax, for most buy-sell agreements, and for internal transfers. Defined by the IRS as the price at which property would change hands between a willing buyer and a willing seller, both informed, neither under compulsion. FMV incorporates discounts for lack of marketability and lack of control where the interest being valued is minority or non-liquid.

Fair Value is the standard for many statutory situations — shareholder dissents, oppression claims, and certain divorce jurisdictions. State-by-state definitions vary, but most exclude discounts that FMV would apply. A minority interest valued under Fair Value in a shareholder dispute is often materially higher than the same interest valued at FMV for tax purposes.

Investment Value is the value to a specific buyer, incorporating synergies, strategic fit, and buyer-specific assumptions. This is the standard implicitly used in M&A negotiations, where a strategic acquirer's willingness to pay is not the same as a pure-play financial buyer's.

409A refers specifically to Section 409A of the Internal Revenue Code, which governs deferred compensation. A 409A valuation determines the fair market value of common stock in a private company for the limited purpose of setting option exercise prices without triggering adverse tax consequences. Its conservative construction is intentional — and is the reason it should not be used for other purposes.

Start with the purpose. Estate planning: FMV. Shareholder litigation: Fair Value in most states. M&A benchmarking: Investment Value or FMV with strategic scenarios. ESOP feasibility: adequate consideration under ERISA — a specific FMV construction.

Then confirm the standard in the engagement letter, and require the report to state it clearly on the first page. Any valuation report that does not name the standard of value is a report you cannot rely on.

The number matters. The standard behind the number matters more.