Strike price and 409A

US tax rules push private companies to set option strikes at or above the fair market value of common stock on the grant date. That FMV comes from a 409A valuation — an independent appraisal updated periodically (and after material events like a financing).

Common trades at a discount to preferred. Preferred has liquidation preference and other rights, so $10/share Series A preferred does not mean common is $10. A 409A might put common at a fraction of the last preferred price. The ratio varies with stage, preference terms and market — do not memorize a single percentage.

The big idea

Picture preferred as a senior ticket with a guaranteed payout in a sale, and common as the leftover. An appraiser prices that leftover. Your option strike is that common price, not the headline round.

A high last-round preferred price with a stale low 409A can look like free money and create AMT risk if you exercise ISOs aggressively. A high 409A with little spread makes options feel "dead" until the company grows into them. Ask for the current 409A and the date it was done.

Walking through a grant

Last round: Series A at $4.00 / preferred share, post-money $40M, 10M fully diluted shares. Fresh 409A sets common at $1.20. Your grant: 40,000 options at $1.20 strike.

Exercise all at once: 40,000 × $1.20 = $48,000 cash

If common is later worth $6.00 in a sale (after preferences — careful), gross bargain is:

40,000 × ($6.00 − $1.20) = $192,000

That is before tax, and before asking whether common actually receives $6 after the preference waterfall.

Common mistakes

• Using last preferred price as your strike. Strike tracks common 409A, usually lower.
• Ignoring the 409A date. A stale low 409A plus a new round is an AMT trap for ISO exercises.
• Forgetting preferences. A $6 "share price" in a deck may be preferred math, not residual to common.

Check yourself

Preferred last sold at $8. 409A common is $2. You get 20,000 options. What is the cash to exercise, ignoring tax?

20,000 × $2 = $40,000. The $8 preferred price is not the strike.

Why would a company raise a round and then redo 409A?

A financing is a material event. The new preferred price and terms change what common is worth.

Key takeaways

• Strike tracks 409A common FMV, usually below the last preferred price.
• Ask for the current 409A and the date it was done.
• Exercise cost is shares × strike; the bargain is shares × (sale price − strike) only after the waterfall.
• A stale low 409A is not free money — it can create AMT if you exercise ISOs.

Further learning

Next, how you earn the grant over time: vesting and acceleration.