Why is the 409A valuation different from my post-money valuation?

Oftentimes, a 409A valuation is different from and lower than the post-money valuation of a company after a financing. Pre- and post-money valuation calculations are simplistic and they assume that the preferred stock and common stock have the same value. For 409A purposes, we have to use a more complicated methodology which treats the preferred stock and common stock differently because the preferred stock and common stock have different rights and values. Preferred stock has liquidation preferences, the power to block financings or sales, and the right to receive dividends. Common stock does not have these advantages and, therefore, is less valuable.

Because preferred stock and other classes of securities (common stock, stock options, etc.) have different rights, we model these differences using the Black-Scholes option pricing model. This model assumes a variety of hypothetical liquidation scenarios and allocates the various classes of securities according to their priority in liquidation for these different scenarios. This approach takes into consideration the liquidation preferences and additional rights of preferred stock and has the effect of lowering the value of the company and the common stock.

It should be noted that certain valuation methodologies used to value a company's common stock in compliance with 409A purposes are only applicable to the issuance of stock options (e.g., internal purposes) and should not be used for strategic purposes such as a financing, merger, or acquisition.