Low-quality IRC 409a being rejected by audit firms. What is your experience?

Mark,

Unfortunately, your lawyer is correct. Audit firms have been known to request that companies pay to receive a second 409A valuation in the specific case where the company is moving rapidly towards a pathway of success and the previous 409A valuation(s) is(are) of questionable quality. Typically, the explicit reason for the "re-do" is that the audit firm does not want to risk the exit being delayed by a "cheap stock" concern brought up by the SEC or the acquiring company (especially if publicly traded). The audit firm would prefer to clean up the potential cheap stock issues prior to filing the S-1, thus the audit firm proactively requests the new retrospective valuation.

For companies, it is a delicate balance managing the 409A risk while trying to be capital efficient. Many advisors, including the BOD and legal counsel, often guide the entrepreneur to err on the side of capital efficiency as it is a more immediate need for the company. As a company grows, this initial short-term focus may cause the company to spend significantly more money, time and effort to prepare for an exit, specifically at a time where the company does not want to be focusing on cheap stock regulations. In the worst of situations, the delay may result in an exit window tightening or closing.

Fortunately, there are many more options available to companies at the present time than existed just a few years ago. First, the AICPA task force on cheap stock has issued a new draft practice aid that provides explicit guidance and will be the "go-to" document for auditors and regulators. Second, many audit firms can and will provide prospective clients (assuming the company is too early to have an audit) with a recommended list of providers. Third, the overall cost of 409A valuations has dropped significantly over the past four years, bringing down the overall cost of compliance.

As with most decisions early in a company's life, it is important to weigh the cost-benefit of your decision accounting for the level of risk for which the entrepreneur and investors are comfortable. Thus, it is important to understand the potential implications of that decision to make the correct assessment.

Thank you.

Steve