How Do I Value My Company So That I Can Grant Stock Options?

Startup companies frequently have to confront this issue.  After the founder stock issuances, the company will want to be able to grant stock options to new hires.  Internal Revenue Code Section 409A requires that stock options be granted at fair market value to avoid adverse tax consequences.

But how do you determine fair market value?

The law does not require that companies hire an independent, third party appraiser to value their stock.  You may want to; it may be very helpful to you if you do.  But the law does not require it.

What the law does require is that the valuation be determined by the “reasonable application of a reasonable valuation method.” The regulations say:

“[I]n the case of service recipient stock that is not readily tradable on an established securities market, the fair market value of the stock as of a valuation date means a value determined by the reasonable application of a reasonable valuation method.”

The regulations go on to say:

“The determination whether a valuation method is reasonable, or whether an application of a valuation method is reasonable, is made based on the facts and circumstances as of the valuation date.”

The regulations go on to say:

Factors to be considered under a reasonable valuation method include, as applicable,

  • the value of tangible and intangible assets of the corporation,
  • the present value of anticipated future cash-flows of the corporation,
  • the market value of stock or equity interests in similar corporations and other entities engaged in trades or businesses substantially similar to those engaged in by the corporation the stock of which is to be valued,
  • the value of which can be readily determined through nondiscretionary, objective means (such as through trading prices on an established securities market or an amount paid in an arm’s length private transaction),
  • recent arm’s length transactions involving the sale or transfer of such stock or equity interests, and
  • other relevant factors such as control premiums or discounts for lack of marketability and whether the valuation method is used for other purposes that have a material economic effect on the service recipient, its stockholders, or its creditors.

We are of course lawyers and not valuation experts, and companies may want consult with valuation consulting firms.

About Joe Wallin

Joe Wallin focuses on emerging, high growth, and startup companies. Joe frequently represents companies in angel and venture financings, mergers and acquisitions, and other significant business transactions. Joe also represents investors in U.S. businesses, and provides general counsel services for companies from startup to post-public.
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