Do I legally HAVE to get a 409A? What happens if I skip it?

Technically, there's no law that says "you must hire a valuation firm." What the law says is that the exercise price of your stock options must be set at or above fair market value on the grant date. How you determine FMV is up to you.

But here's the catch: if you determine it yourself and the IRS disagrees, the burden of proof is on you. And the penalties are severe.

If options are found to be granted below FMV, the affected employees — not the company — face:

• Immediate income recognition (the spread becomes taxable even before exercise)
• A 20% additional penalty tax
• Interest charges dating back to when the options vested

That's a catastrophic outcome for your team. And as a practical matter, it becomes your problem too — you'll likely end up making employees whole, or you'll face lawsuits.

Now, what actually happens? In practice, most startups don't get audited specifically on 409A. The exposure typically surfaces during an acquisition, IPO, or fundraise when sophisticated counterparties do diligence on your cap table. If your options aren't backed by a defensible valuation, it creates a mess — deal delays, purchase price reductions, or reps and warranties you don't want to sign.

The real question isn't "is it legally required?" It's "can I afford the risk of not having one?" For a report that costs a few thousand dollars, you're buying insurance against a problem that could cost orders of magnitude more.