Education

Your First 409A: When a Pre-Revenue Startup Actually Needs One

A pre-revenue founder planning first option grants: when a 409A is required, what a valuer can rely on without revenue, and how to time it before the board.

By 409.AI Team - 2026-10-13

# Your First 409A: When a Pre-Revenue Startup Actually Needs One

If you are a founder with a pre-seed or seed round behind you, no revenue, and a first hire waiting on an offer letter, you have probably heard two opposite things. One says you need a 409A valuation before you talk about options at all. The other says it can wait until Series A. Both are wrong in a way that costs money, and the right answer depends on a date you control: the day your board grants the first option.

This article walks through that date, what a valuer can and cannot use when a company has no revenue, and a worked example with a first grant.

The trigger is the grant, not the incorporation

Nothing in the tax rules requires a valuation when you form a company, open a bank account or issue founder stock. The rule bites when someone is promised the right to buy stock at a fixed price. Under Treasury Regulation §1.409A-1(b)(5), an option is outside Section 409A only if its exercise price can never be lower than the fair market value of the underlying stock on the grant date. If the price turns out lower, the option is deferred compensation, and the person holding it, not the company, owes an additional 20% federal tax plus premium interest on top of ordinary income tax (IRC §409A(a)(1)(B)).

So the first question is not "how old is the company?" It is "has the board approved a grant yet, and what price is on it?" Our guide to [why the board approval date sets the strike price](https://www.409.ai/articles/option-grant-date-board-approval-409a-strike-price) covers the mechanics of that date. For a pre-revenue company the practical rule is simple: get the valuation done before the board meeting that approves the first grant, and set the strike at or above the value it supports.

Founder shares are different. Founders typically buy stock at formation at a nominal price and file an 83(b) election, which is a separate subject covered in [the 83(b) election explained for founders](https://www.409.ai/articles/the-83b-election-explained-for-founders). A 409A valuation is not what protects founder stock purchases. It protects options.

What the regulation asks for when there is no revenue

The regulation says fair market value for stock that is not publicly traded is "a value determined by the reasonable application of a reasonable valuation method," judged on the facts at the valuation date. The factors it lists include the value of tangible and intangible assets, the present value of anticipated cash flows, the value of similar companies, recent arm's length transactions in the company's stock, and discounts for lack of marketability.

A pre-revenue company can still satisfy most of that list. It has no cash flow history, but it often has the most useful input of all: a recent arm's length financing. A priced seed round, a SAFE with a cap, or a convertible note with a discount is evidence of what an outside investor paid for a specific security. The valuer then works backward from that price to the value of common stock, which sits below preferred because it ranks behind it in a sale and cannot be sold freely. That is why [a valuer's allocation method (OPM, PWERM or a backsolve)](https://www.409.ai/articles/409a-allocation-methods-opm-pwerm-backsolve) matters so much at this stage, and why [SAFEs change the common price](https://www.409.ai/articles/how-safes-affect-your-409a-valuation).

Without a financing, the valuer leans on other things: the team, the stage of the product, the cost to rebuild what exists, comparable companies and the plan. The less hard evidence there is, the more the report has to explain, and the more a clear, documented set of inputs matters.

The presumption you are really buying

A valuation is not valid just because someone produced a number. The reason founders pay for an independent report is the presumption of reasonableness in the regulation. If the valuation falls into a category the regulation names, the IRS can only challenge it by showing the method or its application was "grossly unreasonable."

Two of those categories matter to an early company:

1. An independent appraisal that is no more than 12 months old. The regulation also says a previous value is not reasonable if it is more than 12 months old, or if it fails to reflect information that arrived later and may materially affect value. 2. A written valuation of illiquid stock of a start-up. Here, "start-up" means a corporation with no material trade or business that it or a predecessor has conducted for 10 years or more, no publicly traded equity, and no put or call rights over its stock. The valuation must be made reasonably and in good faith, in a written report, by someone the company reasonably decides is qualified. Generally that means at least five years of relevant experience in business valuation, accounting, investment banking, private equity or comparable experience in the company's industry. This presumption is not available if the company can reasonably expect a change in control within 90 days or a public offering within 180 days of the grant.

That second rule is why a hand-built spreadsheet from a founder or a friend of the company usually does not do the job. It may give a sensible number. It does not carry the presumption, and the presumption is the thing you are buying. Our piece on [the safe harbor versus a qualified appraiser](https://www.409.ai/articles/409a-safe-harbor-price-vs-qualified-appraiser) goes into this trade.

A worked example

Take a seed-stage company with no revenue. The cap table before the first grant looks like this:

7,000,000 shares held by the two founders
1,500,000 shares reserved in an unissued option pool
1,500,000 shares of Series Seed Preferred, sold for $1.00 each to investors, so $1.5M raised

That is 10,000,000 fully diluted shares at $1.00, or a $10M post-money value for the preferred. A valuer backsolves from the seed price, applies an allocation method and a discount for lack of marketability, and concludes that common stock is worth $0.32 a share on the grant date. That is an illustration of the order of magnitude, not a rule: common is often a fraction of preferred at this stage, and the fraction depends on the rights attached to the preferred, the time to a likely exit and the volatility used.

The board then approves 50,000 options for the company's first engineer.

With a strike of $0.32 or higher, the grant is outside Section 409A, and the report is the file that supports it.
If someone had instead copied the seed price and used $1.00, the option would be safe from 409A but would cost the engineer $34,000 more to exercise than necessary on 50,000 shares, and would make the offer look worse than it is.
If someone had picked $0.10 because "we have no revenue, so it must be tiny," the option would sit $0.22 below the supported value. On 50,000 options that is $11,000 of spread. The 20% additional tax would fall on the engineer in the year the option vests, not on the company, along with interest and regular income tax.

Founders talk less about the overpriced strike. It is a quiet cost to every hire, because it shrinks the upside you are offering. The underpriced strike is the one that creates a tax problem.

If the options are intended as incentive stock options, there is another reason to get this right: the $100,000 first-exercisable limit is measured at grant date fair market value, covered in [the ISO $100K limit and the 409A value](https://www.409.ai/articles/iso-100k-limit-409a-grant-date-fair-market-value). The Code also gives an ISO some protection when the company made a good faith attempt to set the price at fair market value (IRC §422(c)(1)), and an independent report is the plainest evidence of that attempt.

What triggers a new valuation after the first one

The first report is a floor under your grants for up to 12 months, not a permit. The regulation says a value stops being reasonable when later information materially affects it. For an early company, that usually means:

a priced round, or a SAFE or note on new terms
a term sheet or an acquisition approach
a pivot, a lost key customer or a signed one that changes the outlook
a patent grant, a regulatory approval or the end of a lawsuit

Before any of these, hold new grants until you know whether the old number still stands. Our article on [how often to refresh a 409A](https://www.409.ai/articles/409a-valuation-frequency-how-often-should-you-get-one) lists the events in more detail.

Before you order

A pre-revenue valuation moves faster when the inputs are ready: the cap table, the certificate of incorporation, the financing documents (SAFEs and notes included), the latest financial statements or a cash-burn schedule, the plan and a list of planned grants. [A data request checklist](https://www.409.ai/articles/409a-turnaround-time-data-request-checklist) shows what a valuer will ask for and why.

The takeaway is a sequence, not a deadline on the calendar. Decide the grant. Order the valuation before the board meeting that approves it. Set the strike at or above what the report supports, and write the report's date into the board consent. If you want an expert-reviewed report with a draft in 24 hours, 409.AI's [409A valuation](https://www.409.ai/products/409a) starts at $899.

*This article is general information, not tax or legal advice. Talk to your counsel about your grants.*