Why Your 409A Comes In Below the Preferred Price
A round closes at $10 a share, the appraisal comes back, and the option strike is $3. Founders reasonably ask whether someone has made a mistake. Nobody has: the 409A valuation versus the preferred price is a comparison of two different securities, and the lower number is the correct one for the security your employees are actually being granted.
Why is my 409A valuation lower than what investors just paid?
Because they bought a different security. Preferred stock carries liquidation preference, protective provisions and other rights that common stock lacks, and common is illiquid on top of that. An appraisal prices those differences, and the result is a lower per-share value.
- Preferred rights — preference, protective provisions, sometimes participation — carry real value.
- Common stock has no market to sell into, so a marketability discount applies.
- The gap narrows as a company matures and widens straight after a large preferred round.
What the appraiser is pricing
Preferred stock in a typical financing sits ahead of common on a sale, can block certain decisions, and sometimes participates in proceeds after taking its money back. Strip those rights away and what remains is a minority interest in a private company with no market to sell into. An independent appraisal prices that residual claim, and the discount to the preferred price measures everything the common stock does not get.
This is not a loophole; it is the mechanism that lets you grant options at a defensible strike. It is also time-sensitive, because the appraisal supporting the presumption of reasonableness has a shelf life. The 409A valuation timing checklist walks the trigger points that commonly end reliance on an existing appraisal.
What it means for the people holding the options
A lower strike is good news for employees, and the tax consequences of exercising at it depend on which instrument they hold. The ISO vs NSO tax calculator contrasts what an incentive and a non-qualified option each cost at exercise and at sale on the same grant. Lovie keeps the current 409A attached to the grants priced off it, so nobody is guessing which appraisal a given option was issued under.
The foundational guidance on section 409A is IRS Notice 2005-1.