Key Changes 409a Regulations Faced in 2024

If you are using stock-based compensation to attract and retain talent, you must pay special attention to 409A valuation regulations. As per Section 409A of the Internal Revenue Code (IRC), you must establish your company’s fair market value (FMV) through a 409A valuation. Since the interpretations of this section can evolve, it becomes increasingly important to note how lawmakers, the judiciary, and the Internal Revenue Service (IRS) approach cases involving 409A valuations.

To make this process easier for you, we have put together a couple of cases that can impact how you must treat 409A valuations.

409a Valuations and Disclosure Requirements

Going forward, companies considering liquidity events like initial public offerings (IPOs) might need to disclose any key findings of their most recent 409A valuation report. In February, the Delaware Court of Chancery refused to dismiss a case involving alleged insider trading by Coinbase Global’s key personnel.

Coinbase Global went for an IPO in April 2021 with an issue share price of $250 and on listing day it closed at $328.28, rising 31.31%. However, by the end of May 2021, Coinbase was trading below its IPO issue price. In this period, the lowest low for Coinbase Global’s shares was $208, 16.8% lower than its IPO issue price.

In a 409A valuation performed before listing, the common stock was valued at $303.75 per share. While this is less than the IPO issue price, it is also 29.28% less than the high of $429.54 touched by Coinbase Global on listing day.

It was the court’s opinion that the 409A valuation deduced a fair market value (FMV) price of the shares based on material nonpublic information. Thus, Coinbase Global’s key personnel had an unfair information advantage as insiders over the other investors.

At the time of its IPO, Coinbase Global made 90% of its revenue through brokerage fees. Allegedly, the company failed to disclose that it was facing pressure from its competitors in this segment.

Hence, Eqvista believes that any findings of 409A valuations completed leading up to a liquidity event must be thoroughly reported in the prospectus. It will not surprise us if this becomes a norm or even a requirement.

Expected Regulations in 409a Valuation Methodology

A pain point for stock-based compensation holders as well as issuers has been the lack of clarity in valuation methodology. According to The Menke Group, the first employee stock ownership plan (ESOP) was created in 1956. By 1974, with the Employee Retirement Income Security Act (ERISA) being passed, we even had a legal framework for ESOPs. However, 68 years after the first ESOP, we still do not have formal guidance for 409A valuation.

During an audit, if the Internal Revenue Service (IRS) concludes that the valuation methodology was dubious or inappropriate, naturally, the resulting valuation will be considered unreasonable. This can open a can of worms for both, the employer, and the employee.

In reality, the National Center for Employee Ownership (NCEO) has reported that companies lost an average of $38.55 million annually plus litigation costs due to ESOP-related cases.

However, the SECURE 2.0 Act requires the US Department of Labor (DOL) to issue regulations regarding valuations of private company shares sold to employees via ESOPs. These regulations are expected to come anytime soon in 2024.

In the meantime, the best practice would be to rely on a seasoned valuation service provider like Eqvista.

Rely on Eqvista for Tax Compliance and Stay Ahead of the Curve!

In 2024, we have already seen one important change in the way 409A valuations are treated in the case of liquidity events. Going forward, we may see companies disclose details of their most recent 409A valuation in their IPO prospectus.

In the same year, we also expect some key regulations regarding valuation methodology to be released. Predicting these valuation methodology regulations is just as impossible as it was to predict the importance of disclosing 409A valuation findings for Coinbase Global.

Instead of making predictions and presumptions, it is wiser to always keep an eye out for regulations and rulings involving 409A valuations. This policy of vigilance is what led Eqvista to successfully provide valuation and equity management services to over 15,000 companies in just 6 years since our inception.

Head over to Eqvista and discover why we are a leading valuation service provider!