Secondary Market Transactions and Their Impact on 409A Valuation

Secondary market transactions, where private company shares are bought or sold by investors, can significantly influence 409A valuations. These transactions provide real-world pricing data that valuation experts consider when determining fair market value. However, factors like transaction size, investor sophistication, and timing are carefully assessed to ensure accurate valuation outcomes.

1. SecondaryMarketTransactionsandTheirImpacton
409AValuation
Thestartupecosystemthrivesonaccesstocapitalandtalent,butanotherequally
importantfactorfuelsitsgrowth:equity.Formanycompanies,stockoptionsarenot
justacompensationtoolbutawayofaligningemployees’incentiveswithlong-term
businesssuccess.Akeyelementinthisequationisthe409avaluation,which
determinesthefairmarketvalueofacompany’scommonstock.
Whilevaluationdynamicsoftenrevolvearoundprimaryfundraisingrounds,
secondarymarkettransactionshaveincreasinglybecomepartoftheconversation.
Whenemployees,earlyinvestors,orfounderssellexistingsharestonewinvestors,
thesetransactionscansignificantlyinfluencehowfairmarketvalueisdetermined.
Forcompaniesnavigatingequitymanagement,it’scrucialtounderstandhow
secondarytransactionsintersectwith409avaluations.
WhatAreSecondaryMarketTransactions?
Secondarymarkettransactionsoccurwhenexistingshareholders—suchas
employees,earlyinvestors,oradvisors—selltheirsharestoexternalbuyers.Unlike
primaryfinancings,wherethecompanyissuesnewstockandraisescapital,
secondarydealssimplytransferownershipofalreadyissuedshares.
Thesetransactionscanhappenforavarietyofreasons:
Employeesmaywantliquiditybeforealiquidityevent,suchasanIPOor
acquisition.
Earlyinvestorsmightexitpartiallytolockingains.
Newinvestorsmayseekownershipinagrowingcompanyevenifthebusinessis
notcurrentlyraisingcapital.
Theriseofsecondaryplatformshasmadethesedealsmorecommon,especiallyas
privatecompaniesstayprivatelonger.However,thepresenceofsecondary
transactionsraisesimportantquestionsforvaluationprofessionalstaskedwith
determiningacompany’scommonstockvalueforcompliancepurposes.
WhySecondaryTransactionsMatterin409AValuation?
Thecentralpurposeofa409avaluationistoestablishthefairmarketvalue(FMV)of
commonstockforsettingstrikepricesonstockoptions.SincetheIRSrequiresthat
thesevaluationsbedefensibleandreflectmarketrealities,secondarymarketactivity
cannotbeignored.
Here’swhysecondarytransactionsoftendrawattentioninthiscontext:
PricingSignal:Ifinvestorsarewillingtopurchasecommonorpreferredshares
atacertainprice,itmaysignalahighermarketvaluethanpreviouslyestablished.

2. LiquidityDataPoint:Secondarytransactionsrevealdemandandliquidityfor
sharesintheabsenceofapublicmarket.
RegulatoryScrutiny:TheIRSmayviewsignificantsecondaryactivityasadata
pointwhenassessingwhetheracompany’s409avaluationisreasonable.
AlignmentwithFairMarketValue:Ignoringmaterialsecondarytransactions
couldputacompanyatriskofhavingitsvaluationchallengedlater.
FactorsThatInfluenceHowSecondaryTransactionsAffect409A
Noteverysecondarysaleautomaticallyimpactsvaluation.Professionalsanalyzing
theseeventsweighseveralfactors:
SizeoftheTransaction:Alargevolumeofsharessoldmayindicatebroader
marketconsensus,whileisolatedsalesmaycarrylessweight.
BuyerType:Purchasesbyinstitutionalinvestorsorsophisticatedbuyersmaybe
moreinfluentialthanthosebyfriends,family,orsmallretailbuyers.
StockClass:Preferredstocktradesatapremiumcomparedtocommonstock
duetoliquidationpreferences,dividends,andotherrights.Adjustmentsmustbe
madetobridgethedifferencebetweenpreferredandcommonstockpricing.
CompanyStage:Alate-stagecompanynearingIPOmayseeastronger
correlationbetweensecondarypricingandcommonstockFMVthananearly-
stagestartup.
MotivationBehindtheSale:Distresssales(forpersonalliquidityneeds)maynot
reflecttruemarketvalue,whilearms-lengthtransactionsoftencarrymore
weight.
Thesenuancesensurethatsecondarysalesarenotviewedinisolationbutaspartof
abroadervaluationframework.
IRSPerspectiveonSecondaryTransactions
TheIRSexpectscompaniestoconsiderallrelevantmarketdatawhenconductinga
409avaluation.SecondarysalesarespecificallynotedasafactorthatcanaffectFMV.
However,IRSguidancealsoacknowledgesthatnotallsecondarytradesareequally
reliableindicators.
Ifsecondarytransactionsaresubstantial,frequent,andconductedatarm’slength,
valuationprovidersmaygivethemgreaterweight.Conversely,iftransactionsare
small,infrequent,orinvolverelatedparties,theymaybediscounted.
Ultimately,valuationexpertsmustdocumentwhyandhowtheyincorporated—or
chosenottoincorporate—secondarymarketpricingintotheanalysis.This
defensibilityiscentraltomaintainingIRScomplianceandavoidingpenalties.
BenefitsofConsideringSecondaryTransactionsinValuation

3. Whenhandledcorrectly,incorporatingsecondarymarketdataintoa409avaluation
canprovideseveralbenefits:
Market-ReflectivePricing:Ensuresvaluationsarealignedwithrealinvestor
behavior.
AuditDefensibility:ReducestheriskofIRSchallengesbyshowingthorough
considerationofmarketdata.
EmployeeConfidence:Enhancestrustinthefairnessofstockoptionpricing.
StrategicInsight:Offersthecompanyinsightintohowoutsidersperceiveits
worth.
ChallengesandRisks
Whilevaluable,secondarytransactionsalsoposechallenges:
OvervaluationRisk:Relyingtooheavilyonone-offtransactionscouldinflate
valuationsandleadtocomplianceconcerns.
ComplexAdjustments:Convertingpreferredstockpricesintoanimplied
commonstockvaluerequiressophisticatedmodeling.
MarketDistortions:Urgentsalesorlimitedbuyerscancreateskewedpricing
signals.
CommunicationwithEmployees:Ifemployeesseesecondarysharestradingat
higherpricesthantheiroptionstrikeprice,itcanleadtoconfusionwithout
propercontext.
BalancingSecondaryDatawithOtherValuationApproaches
Arobust409avaluationdoesn’trelysolelyonsecondarysales.Instead,valuation
expertstypicallyblendmultipleapproaches,suchas:
IncomeApproach:Forecastingfuturecashflowsanddiscountingthembackto
presentvalue.
MarketApproach:Comparingvaluationmultiplesofcomparablecompaniesor
transactions.
Asset-BasedApproach:Reviewingthecompany’snetassetvalue,typicallymore
relevantforearly-stageorasset-heavybusinesses.
Secondarytransactionsoftenserveasanadditionalcheckagainstthesemethods
ratherthanthesoledeterminantofvalue.
WhenSecondaryTransactionsCarryGreaterWeight
Secondarydatacanbeparticularlyimpactfulincertaincircumstances:
Multiple,consistenttradesoveraperiodoftime.
Transactionsinvolvingsophisticatedinstitutionalinvestors.

4. Pricingclosetoarecentprimaryfundraisinground.
AcompanynearingIPOoracquisition,wherevaluationsaremoreclosely
scrutinized.
Insuchcases,valuationprovidersoftengivesecondarytransactionssignificant
weightinadjustingtheFMVofcommonstock.
PracticalImplicationsforStartupsandTheirTeams
Forstartups,awarenessofsecondarytransactionsismorethananaccounting
exercise—itaffectspeople.Employeescaredeeplyaboutthestrikepriceoftheir
options,anddiscrepanciesbetweenperceivedvalueandFMVcancausefrustration.
Foundersandfinanceleadersshould:
Communicateopenlywithemployeesabouthowvaluationsaredetermined.
Workwithindependentproviderswhocanobjectivelyassesssecondarydata.
Reassessvaluationsaftermaterialsecondarytransactionstoensurecompliance.
Documentdecision-makingthoroughlytowithstandIRSorauditscrutiny.
Thesestepshelpalignthecompany’sequitystrategywithcomplianceandemployee
morale.
TheRoleofIndependentValuationProviders
Giventhecomplexityofsecondarytransactions,mostcompaniesrelyon
independentvaluationfirmstoconducttheir409avaluation.Independentexperts
bring:
Experienceinweighingdifferenttransactiontypes.
Theabilitytomakeadjustmentsbetweenstockclasses.
KnowledgeofIRSrequirementsandauditdefensibility.
Objectivitythatinternalteamsmaylack.
Thisindependenceensuresvaluationswithstandscrutinywhilekeepingemployee
equityprogramsonsolidfooting.
WhyChoose409.ai?
At409.ai,wespecializeindeliveringaccurateanddefensible409a
valuationstailoredtotherealitiesofstartupsandgrowth-stagecompanies.Our
approachfactorsinnotjustfinancialmodelsbutalsothecomplexitiesofsecondary
transactions,marketdynamics,andcompany-specificconsiderations.Byworking
withus,yougain:
Independent,IRS-compliantvaluations.
InsightfulanalysisofhowsecondaryactivityimpactsFMV.

5. Clearcommunicationtohelpleadershipteamsandemployeesunderstand
equityvalue.
Reliablesupporttoensureyourstockoptionprogramremainsfair,transparent,
anddefensible.
Secondarymarkettransactionscancomplicatethevaluationlandscape,butwiththe
rightexpertise,theycanalsoprovidemeaningfulsignalsaboutacompany’sworth.
At409.ai,wemakesurethosesignalsareinterpretedwithaccuracyandclarity.