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IRC 409A Continued
The most common method of compliance is an independent equity valuation. The primary reason for this is that it shifts the burden of proving that the method reflects fair market value away from the firm and on the IRS.
Any reasonable, compliant equity valuation should include at a minimum the following items:
* The tangible and intangible assets of a company
* The present value of future cash flows
* Public trading prices or private firm sale prices
* Control premiums and lack of marketability discounts
* Whether the method was used for other purposes
* And finally, whether all available information was considered on the valuation date
Although an outside independent appraisal is the most common method of compliance, firms with less than 10-years of history may be able to apply the "Illiquid Start-up Provision" of Section 409A. In order to apply this method, the firm and the valuation must meet the following criteria:
* Again, The firm must be less than 10 years old
* The valuation must be performed by an individual with significant experience, which upon the final ruling is someone with at least 5-years of private equity experience.
* The valuation must be evidenced by a written report
* There can be no put or call features on the stock
* No IPO or sale is expected in the next 6-months
* This is down from the initial guidance period of 12 months
* Finally, all of the valuation requirements mentioned previously MUST be met
Although both approaches to compliance have there pros and cons, the net-net is that in most cases, an outsourced valuation is the advised approach. More often than not, the added cost of the valuation will be more than made up for by the ability of the private firm and its management to maintain the focus of its resources and time.
