Independent 409A Valuations – How to Choose a Firm

August 9, 2017 Shareworks Marketing

Finding a good independent 409A valuation firm can be difficult, especially with all the misinformation out there.

Although we have written the definitive guide to protecting yourself through safe harbor, we still get a lot of questions around independence.

In order for you to qualify for safe harbor and be protected from the IRS in the case of an audit, the 409A valuation firm you choose has to be independent.

So what does being “independent” actually mean?

There is a lot of misinformation spread on this, especially from firms who are not independent.

Luckily the IRS has defined exactly what it means to be an independent valuator and qualify for safe harbor in its “business valuation guidelines”:

valuators will employ independent and objective judgment in reaching conclusions and will decide all matters on their merits, free from bias, advocacy, and conflicts of interest.

So you may be wondering how we can possibly offer 409A valuations if we also collect revenue on our cap table management software?

Providing 409A Valuations and Collecting Revenue for Equity Management Software

Isn’t it a “bias” and “conflict of interest” for a cap table management company to perform valuations and collect a separate revenue stream for other services from the same customers?

If we performed the 409A valuations ourselves or owned the valuation firm that performed them, then the answer would be YES.

In fact, it would be a huge conflict of interest.

According to the IRS: to be an independent valuator, we must be able to employ “independent and objective judgment”. It’s hard to do that if a cap table software company is incentivized to try to keep you happy with other services while also performing a valuation.

If we performed our own 409A valuations or owned our own firm, the pressure would always be there to give you the valuation you want so you continue to use all our other services.

That is why we decided not to perform 409A valuations ourselves or through another firm we own.

Doing so could violate the IRS’ independence clause and consequently disqualify you from the safe harbor protection you thought you had in the event of an audit…

…Which could be extremely costly to you and your employees.

It was an easy choice for us to make, even though prior to founding Capshare, now Shareworks Startup Edition, we founded one of the nation’s most successful valuation firms.

Sure we could make higher margins by owning our own valuation firm. The thought has certainly occurred to us.

But we would rather provide you with low margin, high-quality 409A valuations through a truly independent firm than force you to pay for high margin, low-quality valuations through something we owned.

There is just nothing more important than true independence with a 409A valuation.

Providing Liquidity

The independence issue gets even worse when a cap table management company also sells the shares it is valuing.

Some companies will provide the service to help shareholders sell their shares (we are one of them but as you’ll read further below, we don’t actually do it on our platform.)

Companies who help you to sell your shares themselves are essentially acting as a brokerage firm for private companies.

When you are conveniently valuing the very shares you are selling, it gets fairly difficult to try to make the case for independence.

As we mentioned above, the IRS demands that:

valuators will employ independent and objective judgment in reaching conclusions and will decide all matters on their merits, free from bias, advocacy, and conflicts of interest.

In this case, the cap table management company not only owns the valuation firm valuing the shares but also gets compensated for the sale of those shares and for software services.

You can probably see how that could be an enormous conflict of interest.

So in order to provide liquidity for our customers, we chose to partner with independent, third party firms just like we do with our valuation service.

This creates true independence and safety for you, your company, and your employees.

In the event of an audit, you want to make sure that you don’t lose your safe harbor protection.

You can accomplish this by sticking as close as you can to what the IRS has outlined it requires from valuators.

Choosing a Firm

When choosing a firm, there are a few things to take into consideration.

If you are not getting your 409A valuation through a software company that provides cap table management, you will not have any issues with independence.

You will still want to make sure they pass the checklist of questions to make sure they will provide you with a defensible valuation (which you’ll find further down below).

If on the other hand, you are getting a 409A valuation through a cap table management company, you will want to make sure that they qualify for independence.

Some companies will claim independence and safe harbor without actually providing it, so you’ll want to make sure you ask some specific questions:

  • Will my valuation be performed by your company?
  • If a separate valuation firm or entity is providing the valuation, is that entity owned by your company?
  • Do you provide liquidity for shareholders?
  • Do you provide fundraising assistance?

Be wary of any firm that answers yes to any of the above questions and yet, still claims independence.

And no matter who you choose, you will want to make sure that they pass this checklist of questions:

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