Founders and management should familiarize themselves with 409A valuations early in the company’s life. Section 409A of the Internal Revenue Code will come into play once you start to think about hiring. Internal Revenue Code section 409A applies to stock options and stock appreciation rights (SARs) defined as deferred compensation.

Under section 409A, stock options that have an exercise price less than the Fair Market Value (FMV) of the underlying stock as of the grant date could result in adverse tax consequences for the option recipient. Depending on the severity of the issue, there may be substantial tax consequences, including consequences for the individual taxpayer. Non-compliance carries a hefty price tag in that it renders any deferments under the affected compensation plan taxable for the current year and potentially all prior years.