The Impact of 409A on Preferred vs. Common Share Pricing

1. The Impact of 409A on Preferred vs. Common Share Pricing Pricing equity inside a growing company is never a simple exercise. Each category of shares carries its own weight, privileges, and reflective value of where the business stands at a given moment. Preferred shares respond to investor terms and market expectations. Common shares reflect long-term participation in company performance. Between those two worlds sits a structural element that shapes how the pricing gap is justified: the 409A valuation. A 409A valuation does more than determine the fair market value of common stock. It anchors the internal equity framework against external financial events, acting as a stabiliser when preferred share pricing swings widely during each fundraising cycle. Investors, employees, and founders all rely on it—directly or indirectly—to gauge how equity translates into real value. When the pricing relationship between preferred and common shares becomes skewed, mismanaged, or poorly defended, the effects ripple across the cap table. Equity compensation becomes distorted. Investor expectations shift. Teams begin to question whether their ownership stake reflects their contribution. Why Preferred and Common Shares Behave Differently? Preferred and common shares are priced according to different rules, rights, and expectations. Each responds to distinct pressures. Preferred shares reflect:  Investor negotiation dynamics  Deal-specific protections  Market expectations  Downside protection mechanisms  Liquidity preference layers  Dilution rights and conversion terms Common shares reflect:  Internal company performance  Employee compensation strategy  Probability of liquidity events  Long-term hypothetical enterprise value Because the two categories serve different stakeholders, they follow different valuation logic. A 409A valuation steps in to bridge those logics, making sure common stock pricing remains fair even as preferred share pricing fluctuates with investor appetite.  The preferred price is a financial deal.

2.  The common price is a tax-sensitive benchmark.  The 409A valuation is the firewall that keeps them from colliding. How 409A Creates a Fair Starting Point for Common Share Pricing? Preferred share pricing is set during a fundraising round. It is not based purely on the current state of the company but on negotiated expectations about future growth. Investors pay for potential, not just present-day performance. Common shares, however, must be priced based on fair market value—the price a willing buyer and seller would agree upon without preferential terms. That is where the 409A valuation plays its role. A 409A analysis considers three possible valuation methods:  Market approach: Uses comparable companies and industry benchmarks.  Income approach: Projects future cash flows and discounts them to present-day value.  Asset approach: Values the company based strictly on tangible and intangible assets. Preferred pricing rarely reflects any of these methods by itself. It reflects term sheet risk-sharing and investor incentives. That’s why a 409A valuation becomes essential: it recalibrates the value of common shares back to reality. Why Preferred Prices and 409A Values Often Diverge? A startup may raise a funding round at a high preferred valuation while the 409A valuation places common shares at a significantly lower price. At first glance, this seems inconsistent, but there are clear reasons behind the discrepancy. Reasons Preferred Prices Run Higher  Preferred shares receive priority in liquidation.  Investors get voting rights that shape future rounds.  Anti-dilution mechanics protect downside scenarios.  Larger check sizes justify premium pricing.  Investors receive informational and governance rights. Common shares do not benefit from these advantages. Therefore, the 409A valuation purposely discounts common shares to reflect the risk employees carry relative to investors. The gap is not an accident; it is intentional. How 409A Impacts Common Share Pricing Over Time?

3. As a company grows, the factors that shape common share pricing evolve. The 409A valuation adjusts the FMV based on operational maturity, market conditions, and investor sentiment. These shifts influence how fast the common share price moves relative to the preferred share price. Key elements that shape FMV progression:  Revenue and margins  Market expansion  Team growth  Liquidity horizon  Fundraising environment  Capital reserves  Customer concentration  Competitive shifts While preferred prices jump in big steps (each round), 409A values move more gradually. This creates a smoother curve of common share appreciation compared to the steep climbs preferred shares exhibit. Investors bet on leaps. Employees ride a slope. Why the Gap Between Preferred and Common Prices Narrows Over Time? In early-stage companies, the difference between preferred and common prices is dramatic. Employees may receive options at pennies while investors pay dollars per share. Over time, as risk declines, the difference begins to shrink. Reasons the gap closes:  Lower execution risk  Greater revenue stability  Clearer market presence  Stronger investor confidence  Reduced uncertainty around product fit By the time a company reaches late-stage funding or contemplates public listing, the 409A valuation and preferred share price may sit much closer together. The early gap rewards employees with upside. The later alignment rewards stability and predictability. How Investors View the 409A Valuation When Assessing Share Structure?

4. Investors track how the company manages its equity pricing because it reveals the leadership’s discipline, fairness, and approach to corporate governance. The 409A valuation helps investors assess:  Whether common stock is priced responsibly  Whether the equity program aligns with long-term goals  Whether option pools will remain attractive  Whether dilution concerns are under control  Whether the company can defend its financial assumptions Investors expect preferred shares to be priced aggressively. They expect common shares to be priced realistically. The 409A valuation assures them this balance is maintained. How the 409A Valuation Protects the Company During Fundraising? During fundraising, the company’s equity pricing comes under intense scrutiny. The 409A valuation acts as evidence that common stock pricing is accurate and not manipulated. Without a strong 409A document:  The company’s stock option grants may face audit risk  IRS penalties could apply  Investors may question the cap table  Valuation credibility may erode  Option grants may need repricing A defensible valuation is not about compliance alone—it strengthens negotiating posture. A trusted 409A valuation supports clarity. Clarity supports investor trust. Investor trust supports stronger deal terms. How Dilution Dynamics Are Shaped by the 409A? Preferred and common shareholders experience dilution differently. Investors often negotiate provisions to protect their investment. Employees do not receive such buffers. The 409A valuation indirectly influences dilution impact by determining:  Strike prices  Option pool size

5.  Refresh requirements  Equity allocation strategies A lower common price reduces dilution for employees receiving grants. A higher common price compresses the option pool faster, requiring larger refreshes and affecting the negotiation around future rounds. This subtle interplay between FMV and share structure can change long-term outcomes for both early employees and late-stage hires. Why Companies Cannot Manipulate Common Share Prices to Match Preferred Values? One of the biggest misconceptions among first-time founders is that they can “choose” a common share price. They cannot. The IRS requires an independent review once the company reaches certain complexity thresholds. Preferred pricing is subjective. Common pricing is regulated. This is the reason the 409A valuation exists. It prevents:  Arbitrary common share pricing  Unfair advantages to insiders  Manipulation of employee equity structures  Cap table inconsistencies  Misalignment between financial reporting and tax obligations Attempting to force common shares closer to preferred pricing without justification invites legal trouble. Common Situations Where Preferred and Common Prices Misalign Preferred and common share prices move out of sync during key corporate moments. Some of these moments require immediate 409A recalibration. Situations that create large valuation gaps  Sudden revenue acceleration  Large enterprise contracts  Strategic partnerships  Closing a new funding round  Market shocks  Product launches  Major hiring initiatives

6.  Acquisitions or joint ventures During each of these events, preferred share pricing may shift quickly. The 409A valuation then steps in to bring common share pricing back into alignment. Why Employees Pay Close Attention to the 409A Valuation? Employees rarely pay attention to preferred share pricing, but they watch the 409A valuation closely because it determines:  Strike prices  Tax obligations  Personal risk  Timing of option exercise  Potential future return An accurate 409A valuation influences morale and commitment. If employees feel common shares are overpriced, they may hesitate to exercise options or may consider external opportunities with better equity packages. Investors track this behavior because employee churn affects their investment value. How the 409A Influences Exit Scenarios? The pricing difference between preferred and common shares becomes extremely visible during a liquidity event. In an acquisition or IPO:  Preferred shareholders receive their liquidation preferences first  Remaining proceeds flow to common shareholders  The ratio between preferred and common pricing shapes final payouts A well-supported 409A valuation ensures that the common share price reflects economic reality, which becomes crucial when proceeds are distributed. If common shares were historically undervalued without justification, disputes can erupt among:  Founders  Employees  Investors  Legal advisors A defensible valuation history helps avoid conflict during the most critical financial moment in the company’s life. Why Startups Must Treat the 409A as a Strategic Tool, Not an Obligation?

7. A 409A valuation is often approached as a compliance requirement. But for companies that take equity seriously, it becomes a strategic instrument. When used effectively, a 409A valuation helps:  Maintain alignment between preferred and common pricing  Reinforce trust among employees and investors  Strengthen financial credibility  Support fair option grants  Shape fundraising strategy  Prepare for liquidity milestones It becomes a reflection of how the company treats its equity, its people, and its long- term commitments.