Compliance

Dealing with Incorrect 409A Valuations: How to Identify and Fix Them

A flawed 409A valuation is more than a paperwork problem. If options were granted based on an incorrect FMV, the tax consequences fall on your employees. Here is how to recognize when a valuation has gone wrong, what your remediation options are, and how to prevent it from happening again.

By 409.ai - 2025-07-25

A [409A valuation](https://www.409.ai/articles/what-is-a-409a-valuation-a-comprehensive-guide) is only as good as the inputs and methodology behind it. When a valuation contains errors, uses outdated data, or fails to account for material information, the resulting FMV may not accurately reflect the value of the company's common stock. That matters because options granted based on an incorrect valuation may have been priced below FMV, which creates immediate and significant tax consequences for the employees who received them.

Identifying an incorrect valuation early, understanding your remediation options, and taking prompt action are all critical to minimizing the damage. This post walks through how to recognize when something has gone wrong, what steps to take, and how to prevent the same problem from recurring.

How to Recognize That a Valuation May Be Incorrect

Not every valuation error is immediately obvious. Some surface only when a company undergoes due diligence for a funding round or acquisition and an investor's legal team scrutinizes the historical option grant record. Others emerge during an audit. The earlier an issue is identified, the more remediation options remain available.

Common indicators that a 409A valuation may be incorrect or compromised include:

Significant discrepancies between the valuation and internal financial data. If the concluded FMV is materially inconsistent with what the company's own financial statements, cap table, or projections would suggest, that disconnect warrants investigation. A valuation that seems implausibly low relative to a recent funding round, or implausibly high relative to the company's actual financial position, should be reviewed carefully.

Material information was omitted or not adequately considered. If a significant event occurred before the valuation date that was not reflected in the report, such as a closed funding round, a major customer contract, or a change in the capital structure, the valuation may not accurately capture the company's value as of the measurement date. Reviewing the report's company overview and financial analysis sections against what you know was true at the time is an important check, as described in the [409A valuation report walkthrough](https://www.409.ai/articles/decoding-a-409a-valuation-report-walkthrough).

The methodology is inappropriate for the company's stage. A pre-revenue company valued primarily through a DCF model, or a post-funding company where the appraiser ignored the most recent priced round, may have a valuation that will not withstand scrutiny. Methodology mismatches are one of the most common sources of defensibility issues.

The appraiser lacked the required independence or qualifications. A valuation conducted by someone with a financial interest in the company, by the company's own CPA without independent appraisal credentials, or by a provider who cannot demonstrate USPAP-compliant methodology does not qualify for IRS safe harbor. Grants priced using such a valuation are not protected regardless of how recently the report was issued.

The cap table used in the valuation was inaccurate. Even minor errors in share counts, equity class classifications, or the terms attached to SAFEs or convertible notes can cascade through the entire equity allocation model and alter the concluded FMV materially.

Step 1: Conduct an Internal Review

The first step when you suspect a valuation may be incorrect is to conduct a thorough internal review before engaging external parties. Compare the valuation report against your actual financial statements, cap table, and any significant events that occurred around the measurement date. Identify specifically what appears to be wrong, what information may have been omitted, and what the likely direction of the error is, meaning whether the FMV was overstated or understated relative to what you believe the correct value should have been.

Understated FMV (options may have been granted below actual FMV) is the scenario that creates direct regulatory exposure for employees under Section 409A. Overstated FMV (options granted above the actual FMV) creates a different problem: options that are less attractive to employees than they should be, though without the same immediate tax consequences.

Document your findings carefully. This documentation will be important if you need to engage legal counsel or work with a new appraiser on a corrective valuation.

Step 2: Engage Qualified Legal and Valuation Professionals

Incorrect 409A valuations, particularly those that may have resulted in options being granted below FMV, involve complex legal and tax considerations that require professional guidance. Engage legal counsel with Section 409A expertise alongside a qualified, independent appraiser. Do not attempt to assess or remediate the exposure internally without this support.

The valuation professional can conduct a retrospective analysis to establish what the FMV should have been as of the original measurement date. This analysis uses contemporaneous data available at the time to reconstruct a defensible value. As discussed in [the post on missed deadlines and correction procedures](https://www.409.ai/articles/409a-valuation-deadline-correction-procedures), a retrospective valuation does not restore safe harbor protection for past grants, but it establishes a documented basis for the values that were used, which significantly strengthens the company's position if the issue is ever raised in an audit or during due diligence.

Step 3: Determine the Appropriate Corrective Measure

The specific remediation path depends on the nature of the error, how many employees are affected, whether any options have already been exercised, and the timing relative to the tax year in which the grants were made. Your legal counsel will advise on the most appropriate approach given the specific facts. The most commonly used remediation strategies include the following.

Option repricing. If options were granted at a strike price below the correct FMV, repricing raises the exercise price on the affected grants to at or above the corrected FMV. This eliminates the Section 409A exposure for employees but requires board approval and employee consent. It also has accounting implications under ASC 718 that must be addressed with the company's auditors. Employees whose options are repriced upward may not be happy about the change, which makes transparent communication essential.

Rescission within the same tax year. In some cases, non-compliant option grants can be rescinded and reissued at the correct FMV, provided this is done before the end of the calendar year in which the grant was made. This is only available for recent grants and must be evaluated carefully with legal counsel, as rescission has its own tax and contractual implications.

IRS correction programs. The IRS has established correction programs under the Employee Plans Compliance Resolution System (EPCRS) that allow companies to correct certain plan errors before the IRS discovers them, with reduced penalties. The Self-Correction Program (SCP) and the Audit Closing Agreement Program (CAP) are the primary mechanisms. These programs are most applicable to errors in qualified retirement plans, and their applicability to Section 409A violations specifically should be evaluated with legal counsel who specializes in this area. Not all 409A errors are eligible for these programs.

Step 4: Communicate with Employees and Stakeholders

Transparency is both a legal and a cultural obligation when a valuation error has affected employee equity. Employees whose options may be subject to repricing or rescission deserve a clear and honest explanation of what happened, what the company is doing to address it, and what the impact will be on their compensation.

How this communication is handled has a significant impact on employee trust and morale. Companies that acknowledge the issue proactively, explain the remediation plan clearly, and follow through on their commitments typically manage the situation far better than those who minimize or delay the disclosure. Depending on the scope of the issue, disclosure to investors and the board is also required.

Step 5: Prevent Recurrence

After addressing the immediate issue, the company should evaluate what went wrong in the valuation process and implement controls to prevent a recurrence. Common root causes of incorrect valuations include:

Using a provider without the qualifications or independence required for safe harbor, submitting incomplete or inaccurate financial data or cap table information, failing to disclose a material event to the appraiser before the valuation was completed, or not reviewing the draft report carefully before accepting it.

The review process described in the [409A valuation report walkthrough](https://www.409.ai/articles/decoding-a-409a-valuation-report-walkthrough) provides a practical framework for verifying that the inputs and methodology in any future report accurately reflect the company's actual situation before the report is finalized and used to price grants.

Conclusion

An incorrect 409A valuation is a serious compliance issue, but it is one that can often be meaningfully addressed when identified early and handled correctly. The key is prompt action: conducting an internal review, engaging qualified legal and valuation professionals, selecting the appropriate corrective measure, communicating transparently with employees, and building better processes for the future. The companies that handle these situations well are the ones that treat the correction as an opportunity to strengthen their equity program, not just a problem to minimize.