Why 409a Valuations Are Also Required For Non-US Private Firms?

The 409A valuation is a third-party appraisal of a firm’s common stock, which helps estimate the price of purchasing shares. This assessment relies on the FMV (Fair Market Value). Whether a non-US private firm requires this appraisal depends on both the characteristics of the firm and the specifics of the valuation project. Surprisingly, when offering stock to employees who are US nationals or US tax residents, non-US firms must adhere to US tax laws for certain key decisions. In this case, a non-US equity transfer must comply with US Internal Revenue Code Section 409A.

What Does 409A Imply?

409A governs the taxation of various “deferred compensation” programs where an employee is compensated in one taxable year but must pay taxes in a future year. In general, 409A requires deferred compensation plans to meet several complex conditions, and failing to do so can lead to significant tax penalties. However, 409A does not generally apply to non-US deferred compensation structures. Their equity frameworks and accounting practices usually follow local regulations, which differ from US tax standards.

When Offering Equity To US Workers, How Does A Non-US Business Comply With 409A?

To qualify for an exemption, a non-US firm must first determine the fair market value of its shares before issuing stock options. Obtaining a 409A valuation helps establish a defensible strike price for stock options, aligning them with the FMV of the shares. 409A valuation guidelines mandate that the valuation be conducted by an independent third party or the board of directors to establish the FMV.

The appraiser calculating the FMV must consider various factors, such as the value of assets, current and future revenues, and the selling price of comparable companies. Since non-US assessment criteria may differ from US standards, leading to potential violations of 409A, the valuation must be conducted according to US norms. A 409A valuation remains valid for a maximum of 12 months, or until a material event such as new funding.

It’s also beneficial to include an addendum detailing 409A laws in the non-US employee stock option plan. Any foreign shareholding agreement signed by a US employee should have an addendum stating that the stock agreement complies with 409A. This requires reviewing the amendment and employee stock option plan with both US and local legal counsel.

What Happens If The 409A Isn’t Followed?

Failure to comply with 409A can lead to severe tax penalties and fines for US employees and non-US startups. The discrepancy between the market price and the strike price will result in the 409A valuation being considered as income for the US employee, even if the employee hasn’t yet exercised the option. For instance, if a company, X, has a strike price of $0.01 per share and the market price is higher, the difference is treated as income for employee Y, a US worker, who will be taxed on this benefit.

The non-US startup is responsible for reporting any 409A-related non-compliance on the employee’s tax form and withholding the applicable income tax. If the company fails to meet these obligations, it may also face consequences from the IRS. The primary tax penalties, however, are imposed on the US employee. In some cases, companies choose to cover the additional tax burden on behalf of affected employees to maintain goodwill.

Concluding Remarks

A 409A valuation is a crucial process for non-US private firms offering equity to US employees. By determining the Fair Market Value (FMV) of shares, these firms can comply with US tax regulations and help employees avoid substantial tax penalties. Under 409A, the direct tax consequences fall primarily on employees, while companies may face indirect repercussions such as reputational damage, employee dissatisfaction, and potential liabilities if reporting or withholding duties are not met. Adhering to 409A guidelines not only protects employees from unnecessary tax exposure but also safeguards the company’s credibility and ensures continued compliance with IRS expectations.

Partnering with Sharp 409A for 409A valuation

Meeting 409A valuation requirements is essential for protecting both employees and companies from tax risks. Sharp 409A delivers accurate, defensible, and IRS-compliant 409A valuations for both US and non-US private firms. Our experienced analysts ensure that businesses meet regulatory standards while safeguarding employees from unnecessary tax exposure. With our end-to-end support, startups and established firms alike can confidently manage equity compensation, strengthen compliance, and focus on growth. Contact Sharp 409A today to discuss your 409A valuation needs and ensure your business remains compliant and secure.

Note* “This information is not intended as legal advice and should not be considered a substitute for consulting with an attorney regarding your specific situation. Please contact a lawyer for professional guidance on any legal matters.”