A 409A valuation is an independent appraisal of the fair market value (you’ll sometimes see this referred to as the “FMV”) of a private company's common stock, as required by section 409A of the IRS's internal revenue code. This valuation determines how much a share of the company's stock would go for on the open market and is crucial for offering equity to service providers without risking IRS penalties. The 409A valuation helps ensure that companies accurately value themselves, preventing potential tax evasion or misleading investors.

Private companies, especially early-stage startups, must obtain a 409A valuation before issuing shares (or options to purchase shares) to employees. Unlike public companies that rely on their current stock price, private companies need to determine the fair market value of their common shares. This value will be the “strike price” in the case of options, and the purchase price in the case of a restricted stock grant. Obtaining "safe harbor" status, which protects the valuation from IRS scrutiny, is beneficial and requires working with a qualified, independent, third-party appraiser.