409A” or “Section 409A” refers to Section 409A of the Internal Revenue Code, which is a complex and often counterintuitive set of tax rules applicable to Equity Compensation, including the grant and receipt of Stock Options, severance and other types of  Deferred CompensationSection 409A imposes harsh and punitive tax consequences on the recipients of “in the money” Stock Options and other types of Deferred Compensation that do not comply with Section 409A.  Importantly, Section 409A applies to all Privately-Held Companies and their Stock Option programs, even though the Fair Market Value of a Stock Option may be very difficult to determine for illiquid Securities.  Also, whether or not an Equity Compensation award is compliant with Section 409A is often looked at in retrospect, whether by the SEC or other regulators or by potential Investors or Acquirers.

For this reason, most Privately-Held Companies obtain regular, independent, third-party valuations of their Common Stock, commonly referred to as a “Section 409A valuation,” in order to ensure that their Stock Option grants fit within the “safe harbor” for compliance with Section 409A.

Deferred Compensation exists when an employee, consultant or Board member has a contractual right to compensation that may be paid in later taxable years and includes many arrangements not typically thought of as Deferred Compensation (e.g., severance benefits, Stock Options, and other equity awards). If Deferred Compensation arrangements are not exempt or compliant with Section 409A, then there are significant adverse tax consequences, even if the non-compliance is unintended.