409a valuations set the price of the common stock generally after preferred stock has been purchased by the investing angel or venture capitalist. Preferred stock might have been purchased for a dollar a share—but once preferred stock has been sold by the company, it has to be paid back first before common stock has any value.
So imagine an extreme situation where a company which just started last week raises $80 million in preferred stock. The odds that the full $80 million is ever even paid back is probably low so it wouldn't be crazy to see the common stock valued at almost zero/nothing. Employees get stock options in common stock—not preferred—so somebody has to set the strike price for the options on their common. That's the purpose of the 409a valuation—it sets the price at which common stock options can be bought and thus converted from options into actual stock ownership.
Related or Semi-related Video
Finance: What are Angel Investors and Se...8 Views
Find it a la shma What are angel investors and
seed funds Just call me angel Thanks That's All right
It's early in the morning here and we just do
that sometimes Yeah All right Well an angel investor is
typically i'm sorry Won't sing again An angel Investors typically
someone who was wildly successful in an entrepreneurial venture of
their own They feel a kind of moral obligation to
recycle their winnings And in most cases very very early
stage companies are so extremely risky with failure rates over
ninety nine percent Well that it takes some kind of
angel to come in and invest the first few hundred
grand Get them started building that nose picking device the
world has always wanted no And since in most cases
very early start ups have absolutely no idea what they're
worth So many initial angel investments carry no price meaning
that there was only one term carried by the money
invested It will be valued at say a ten percent
or whatever number discount toe whatever valuation The next round
if there is one values the company at while the
first few million bucks into google by a small handful
Of already successful silicon valley types ended up being converted
into stock in their initial or a round which was
done at a whopping almost seventy million dollars It was
done at the height of the first internet bubble and
while timing is everything sometimes google's original investment netted it's
angel investors some ten thousand times their money and spawned
a whole many industry in angels getting together hoping tio
you know do more googles When angels pool their money
they create what is called a seed fund think seeds
planted in the ground to eventually bear fruit You know
like that And when seed investors are right yeah sometimes
they make that ten thousand times their money thing and
yahoo google facebook and a small handful of others all
live in this lofty world of ten thousand xers We're
on ly the loftiest of angels fly q's call me
change All right i'll stop Hey if you've got google
money and you can call me whatever you want No
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