Guide
When a 409A valuation expires, and what a material event does
Updated
The most common 409A failure is a good valuation applied to a grant it does not cover. Both ways that happens are avoidable once written down.
Question 1
What are you granting?
Section 409A bites on stock rights whose exercise price is below the fair market value of the underlying stock on the grant date. Not every equity award raises the question.
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The twelve months runs to the grant
The condition is that the appraisal be as of a date no more than 12 months before the relevant transaction to which the valuation is applied. The relevant transaction is the grant.
So a valuation dated 1 March supports grants up to the following 1 March, and not one made on 15 March while the replacement is in progress. Grants in that gap are outside the presumption, and they are usually made by a company that believes it is fully compliant because it buys a valuation every year.
The fix is a calendar, not a policy
Commission the refresh with enough lead time to be delivered before the current one expires, and put a hard stop on grants between expiry and delivery.
Board consents are where this leaks. An option approved by written consent over several days has its grant date when the last signature arrives. That date is what the twelve months is measured to.
Material events end it early
A priced funding round is the clearest case. It is new evidence about the value of the company's equity, from an arm's length transaction. Applying a pre-round valuation to a post-round grant applies a method to facts it did not consider.
Others: a signed term sheet or acquisition offer, the loss or gain of a customer that materially changes the outlook, or a significant revision to projections. A secondary sale of common stock at a price the company knows about counts too. None is a bright-line rule in the regulation, and a later reader will know about all of them.
What to do about grants already made in a gap
Establish the facts before deciding anything: the grant dates, the board approvals, the exercise prices, and the valuation in force on each date. Almost every route to fixing this starts by proving exactly what was granted and when, and companies routinely find the record is less clear than they assumed.
Then take tax advice on the specific grants. The options depend on timing, on whether the grants are outstanding, and on whether the exercise price was below fair market value at grant. A fresh valuation cannot answer that last question retrospectively on its own.