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9:00 am - 6:00 pm409A Valuation vs. VC Valuation: What Startup Founders Must Know in 2025
It’s strategic for startup founders preparing to raise capital or issue stock options to understand the difference between VC Valuation and 409A valuations.
On paper, the valuation of your startup from the most recent investment round may be noteworthy. However, you’re also dealing with a substantially lower 409A valuation on the inside, which affects the pricing of employee stock options.
The functions of these two valuation categories are completely different. It can lead to misunderstandings, tax risks, and employee discontent if they are perceived as interchangeable.
The meaning of each valuation, its calculation, and the reasons founders should approach them as distinct but equally significant financial instruments are all explained in this tutorial.
What Is a 409A Valuation?
When awarding stock options or RSUs, the IRS requires an independent evaluation of the fair market value (FMV) of your company’s common stock, known as a 409A valuation.
Why It Is Important
- Sets the strike price for employee stock options
- Ensures compliance with Section 409A of the tax code
- Protects employees from severe tax penalties
Key Features:
- Applies only to common stock
- Based on current fair market value, not future potential
- Applies discounts for illiquidity, lack of control, and marketability
- Must be performed by a qualified, independent valuation firm
- Valid for 12 months (or until a material event like a funding round)
If properly constructed, a defensible 409A value provides Safe Harbour protection from IRS examination.
What Is a VC Valuation (Preferred Stock Pricing)?
The negotiated value of your business during a venture capital financing round is known as a VC valuation. It represents the price that investors are prepared to pay, typically in the form of preferred stock with additional rights and safeguards.
What It Represents:
- The company’s value as seen by investors
- Based on future growth projections and expected returns
- Influences ownership, dilution, and board control
Preferred Stock Rights That Affect Valuation:
- Liquidation preferences
- Anti-dilution protection
- Board seats or voting power
- Conversion rights at IPO or exit
For instance, a $12 million investment buys a 20% ownership. That suggests a post-money valuation of $60 million. However, your 409A FMV for common shares may be $18 million, which would indicate reduced marketability, fewer rights, and a lack of liquidity.
409A Valuation vs. VC Valuation: Key Differences
Aspect | 409A Valuation | VC Valuation (Preferred Stock) |
Purpose | IRS compliance, option pricing | Fundraising, ownership negotiation |
Stock Type | Common stock | Preferred stock |
Valuation Method | Independent appraisal (DCF, OPM, comps) | Negotiated deal terms, market sentiment |
Value Level | Conservative (discounted FMV) | Aspirational (future-facing) |
Discounts Applied? | Yes—illiquidity, control, marketability | No—premium price due to rights and exit assumptions |
Who Determines It | Independent third-party appraisers | Founders and investors through negotiation |
Why 409A Is Lower Than VC Valuation
A number of financial and structural assumptions fuel the disparity:
1. Time Horizon
- 409A makes no immediate exit assumptions.
- VCs anticipate liquidity within three to seven years.
2. Rights and Defenses
- There are no unique benefits to owning common shares.
- Preferred stock has first rights and protections against declines.
3. Adjustments for Risk
- For illiquidity, minority status, and lack of market access, 409A offers discounts of 30–40%.
- VC valuations focus on future potential rather than current marketability.
4. Objectives of Valuation
- 409A is for tax compliance, and authorities must be able to support it.
- Venture capital (VC) valuations are used to raise funds and may be overly optimistic or even inflated due to competition.
The 2025 FMV of 409A common stock typically ranges from 20% to 50% of the most recent round’s preferred stock price.
Does a Low 409A Hurt Fundraising?
No—and it shouldn’t.
409A values are not market signals; rather, they serve as compliance instruments. Investors do not base term sheets and valuations on your 409A. Instead, they focus on:
- Market size and growth potential
- Product traction
- Revenue model and margins
- Team credibility
- Exit potential
Employees benefit from a lower 409A because it allows them to purchase stock at a cheaper strike price without affecting VCs’ assessment of your business.
When to Get a 409A Valuation
You need a new 409A valuation:
- When releasing fresh RSUs or stock options
- Following a significant event (a major contract, purchase, or funding)
- Every 12 months or more
- When equity is included in secondary transactions, due diligence, or M&A
The best course of action is to update your 409A within ninety days after a significant investment round.
Is the Board Able to Set the 409A?
According to the IRS, yes, but doing so may nullify Safe Harbour protection unless specific requirements are met.
A safer strategy
Select a qualified third-party valuation company, especially one whose appraisers are certified.
- ABV® (Accredited in Business Valuation)
- ASA® (Accredited Senior Appraiser)
- CVA® (Certified Valuation Analyst)
Final Thoughts for Founders
Knowing the difference between 409A and VC valuations is crucial. It affects your hiring, fundraising, and long-term success.
- 409A valuations are for legal compliance and equity compensation.
- VC valuations reflect investor confidence, deal terms, and growth potential.
Treat them differently. Use both with careful consideration.
Need a Certified 409A Valuation?
At Transaction Capital LLC, we offer fast, audit-ready 409A valuations that follow IRS standards. Our expert team prepares them in just 3–5 business days, using industry-standard methods.