This article is valuation commentary. It is not legal, tax, accounting, or investment advice. Specific engagements depend on facts and applicable professional standards.
Two different securities, two different questions
The 409A and the fundraising round are answering different questions about different securities. A priced round sets a price for preferred stock with a specific bundle of rights. A 409A determines fair market value of common stock for tax-compliance purposes. Even on the same date, the two numbers will rarely match, and they aren’t supposed to.
The IRS regulation is explicit: for stock that is not readily tradable, the fair market value has to come from the reasonable application of a reasonable valuation method. The method has to consider, as applicable, tangible and intangible assets, anticipated cash flows, market evidence from similar companies, recent arm’s-length transactions, control premiums, marketability discounts, and consistent application across other meaningful purposes. A method is not reasonable if it ignores material information.
What preferred stock actually carries
Preferred shares typically carry rights that common stock does not. Each of these affects how value gets allocated across the capital structure:
- Liquidation preference: a guaranteed return ahead of common in liquidation, often at least the original investment plus accrued dividends
- Participating preferred: in some structures, the preference is followed by additional participation pro rata with common
- Anti-dilution protection: weighted-average or full-ratchet protection against down rounds
- Dividends: cumulative or non-cumulative; sometimes accruing
- Protective provisions: veto rights over specified corporate actions
- Conversion rights: option to convert to common, typically 1-for-1 unless adjusted
- Redemption rights: in some structures, the right to require the company to repurchase the shares
None of those rights are available to common-stock holders. That difference in rights is why a $100M post-money fundraise can produce a common-stock fair market value far below $100M divided by the diluted share count.
How the allocation actually works
Most 409A valuations start with a total enterprise or equity value, then allocate that value across the cap table based on each class’s rights. The allocation framework determines how much of the total ends up attributed to common.
Why the two numbers can diverge sharply
The same enterprise value can produce a $100M fundraising headline and a substantially lower common-stock conclusion. A few mechanics explain most of the gap:
- Liquidation preferences ahead of common reduce the value remaining for common in downside cases
- Participating preferred further reduces common’s share even in upside cases
- Marketability discounts reflect the reality that common-stock holders cannot easily sell their position
- Time to liquidity compounds the discount, because common-stock holders bear path risk preferred holders are insulated from
- Volatility of the underlying enterprise affects how much “option value” common stock retains in OPM frameworks
When the recent round is the right anchor (and when it isn’t)
A fresh, arm’s-length financing is relevant evidence. The regulation specifically lists arm’s-length transactions among the factors a reasonable method should consider. But a recent round is an input, not an automatic answer. Several conditions affect whether the round can anchor the valuation:
- How recent is recent? A round from 90 days ago carries different weight than one from 11 months ago, especially if operating performance has changed.
- Was the round priced? SAFEs and convertibles aren’t priced rounds in the traditional sense; they’re bridge instruments with their own valuation challenges.
- Did the round include strategic investors? Strategic-led rounds may include synergy value a generic market participant wouldn’t pay for. Buyer-specific synergies are typically excluded from fair market value.
- What rights did the new investors get? A round at a high valuation with aggressive liquidation preferences may not push common stock as high as the headline suggests.
Mistakes founders make explaining 409A to employees
The communication challenge is real: employees who know the company just raised at $200M post-money find it hard to accept a 409A common-stock value at $0.85. The math is correct, and the problem is usually the framing.
The right framing is that the strike price reflects what common stock is actually worth on the grant date, given the rights stack above it. The lower the strike, the better positioned the option is to deliver value if and when the company succeeds. Employees benefit from a low strike price rather than losing out from one. Founders who treat the 409A as something to be defended or apologized for create unnecessary anxiety.