The process determines the fair market value (FMV) of a private company’s common stock. This assessment is crucial because it establishes the strike price for employee stock options. If the strike price is set too low, it can trigger significant tax penalties for both the employee and the company under Section 409A of the Internal Revenue Code.
Accurate establishment of this value is vital for attracting and retaining talent by offering competitive equity compensation packages. Furthermore, maintaining compliance with tax regulations surrounding equity grants protects both the company and its employees from adverse financial repercussions. Historically, prior to the formalization of guidelines, valuation discrepancies often led to disputes with the IRS, prompting the development of standardized methodologies.
