Section 409A of the US Internal Revenue Code requires that stock options be granted at or above the 'fair market value' of the underlying stock on the grant date. Set the strike too low and the IRS treats the entire grant as deferred compensation — with brutal tax penalties.
To comply, private companies hire independent appraisers (Carta, Aranca, Hilltop) to produce a 409A valuation report, typically refreshed quarterly or after major events like a new funding round.
How appraisers calculate 409A
The 409A appraiser uses standard private-company valuation methods: discounted cash flow, market multiples, and the option pricing model (OPM) for allocating value between preferred and common shares. The OPM is what creates the big discount: preferred stock has liquidation preferences and other rights that aren't shared by common stock.
In practice, a typical 409A for common stock comes out at 30–50% of the preferred-stock price from the most recent funding round. As the company approaches IPO, the gap narrows.
Why you should care
Your strike price was set based on the 409A on your grant date. If you joined just before a big round, the 409A was low — and the gap between your strike and today's value is enormous. If you joined just after a big round, the 409A had already absorbed that round's pricing and your strike is higher.
Joining a startup just before a planned funding round is often the single biggest determinant of how valuable your equity ends up being. Timing matters more than negotiation.