Why a Down Round Forces a New 409A
A 409A valuation after a down round has to be redone, because the priced round is new material information the prior report never saw.
Treasury Reg. 1.409A-1(b)(5)(iv)(B)(1) counts “recent arm’s length transactions involving the sale or transfer of such stock or equity interests” among the factors a reasonable method has to weigh. It also says a previously calculated value isn’t reasonable later if it “fails to reflect information available after the date of the calculation that may materially affect the value of the corporation.”
That test and the 12-month outer limit are independent disqualifiers joined by “or.” A four-month-old report is still unusable once the round prices.
What goes away is the safe harbor. The presumption of reasonableness at 1.409A-1(b)(5)(iv)(B)(2) is rebuttable only on a showing that the method or its application was “grossly unreasonable.” Outside it you defend your own method against a signed purchase agreement showing a lower price.
The event is the pricing, not the closing. Grants made between a signed term sheet and a close three months later price off a report that no longer reflects available information, so freeze grants until the refreshed one lands. For the full material-event list and the cadence question, see when to refresh your 409A.
The new report usually concludes a lower common fair market value. It doesn’t have to. Common stock value isn’t the preferred price, it’s an allocation output, and a down round moves several of those inputs at once.
- Total equity value falls. A backsolve to the new, lower preferred price pulls the whole allocation down, which is why common usually falls.
- The preference stack can grow. A senior series, participating preferred, a liquidation multiple, or full-ratchet anti-dilution raises the strike on common’s call option, so common falls further than the headline discount.
- The preference stack can shrink. In a pay-to-play or cram-down recapitalization, prior preferred converts to common and loses its liquidation preference, which can raise per-share common value even though the preferred price fell.
- Time to liquidity and volatility move. Both raise the option value of common.
So nobody can quote the number before the allocation runs. Your down round 409A engagement should open with the full capital structure on the table, preference terms and recapitalization mechanics included, because those are inputs and not footnotes. When indinero scopes a refreshed 409A, that’s the first ask. See 409A valuation methodology for the allocation and our guide to preferred shares for the stack.
What Happens to Options Granted at the Old Strike Price
Nothing happens automatically to options granted at the old strike price. An exercise price is fixed at grant, and a later 409A report doesn’t touch it.
There’s no deemed modification, no tax event, and no accounting event for either side. The grant was compliant when made because the strike met fair market value on the grant date under 1.409A-1(b)(5)(i)(A)(1), and that test runs once.
The option just stops working as compensation. Three effects follow.
It’s worth nothing on exercise. An employee holding a $4.10 strike against a new $2.30 fair market value would pay $4.10 for what your own appraiser values at $2.30. Rational holders don’t exercise, and they don’t forfeit either, because the option still carries time value. So the grants sit on the cap table consuming the pool, with no retention effect and no cash. The company keeps expensing the original grant-date fair value, because ASC 718 expense doesn’t reverse when an award goes underwater.
New hires get a better deal than the people who stayed. Every grant made after the refreshed report prices at the new lower fair market value. The engineer who stayed through the round holds a strike the candidate starting next month can’t be given, and the gap widens with tenure.
The gap shows up as job search. A 2005 Personnel Psychology study of 610 U.S. executives, “Out-of-the-Money: The Impact of Underwater Stock Options on Executive Job Search,” found a positive association between the share of a portfolio underwater and job search activity.
Underwater stock options aren’t a tax problem for the holder, and leadership should say so plainly in the all-hands. The real failure mode is the founder who promises a reprice before the board has run the analysis. That promise is itself an “offer to grant” problem under ASC 718-20-35-8. Say what you’re evaluating, not what you’ll do.
For the question that follows every down-round all-hands, why common trades below preferred, see our guide to common stock.
The Repricing Route and What It Costs
A straight reprice lowers the exercise price on existing options to the current 409A fair market value and changes nothing else. Same share count, same vesting, same expiration. It’s the option repricing startup boards consider first, and it generally needs no holder consent, because no holder is made worse off.
A reprice isn’t just a price change. Under 1.409A-1(b)(5)(v)(A) a modification “is considered to be the grant of a new stock right,” and (b)(5)(v)(B) reaches any change that may give the holder a “direct or indirect reduction in the exercise price … regardless of whether the holder in fact benefits.”
The sequence is fixed, and the order is what gets companies in trouble.
- Get the refreshed 409A first. The new strike has to clear fair market value on the modification date, not the original grant date and not the date the board started talking about it. A resolution dated ahead of the valuation report is a problem your auditor will find. Our 409A engagement timeline covers how long that takes.
- Confirm plan authority. Most plans give the board amendment authority broad enough to cover a reprice. Some prohibit repricing without stockholder consent, and investor rights agreements, voting agreements, and credit agreements can each impose consent requirements of their own.
- Take board action. The resolution names the new exercise price, the eligible population, and the effective date. Directors are approving a transfer of value from preferred holders to option holders, so the minutes should carry the business rationale.
- Test whether stockholders have to vote. Private companies generally don’t need approval for the reprice itself. The pool top-up is different. Under 26 CFR 1.422-2(b)(2)(iii), increasing the maximum aggregate number of shares issuable under the plan is the adoption of a new plan requiring stockholder approval.
- Run the tender offer analysis. A uniform strike reduction with no election isn’t a tender offer, because there’s nothing to tender. Give holders a choice and the window math below applies.
- Document it. Amended agreements go to holders, the cap table gets updated, and the audit file takes the valuation report, the resolution, the fair value computation, and the plan authority analysis.
Option Exchanges and Cancel and Regrant
A stock option exchange program cancels underwater options and issues something else in their place. Companies pick this over a reprice when they want to change more than the price.
The third path is neither. Leave the underwater grants alone and issue new options at the new lower fair market value. No modification, no incremental fair value measurement, no ISO reset, no tender offer analysis. The cost is dilution, and it only works if the remaining pool can absorb a meaningful second layer.
Value-for-value exchanges are the market norm
One-for-one exchanges have become rare, pushed out by shareholder opposition and the ASC 718 cost. Current practice offers fewer replacement options at the current price, so what the employee receives is worth no more than what they gave up and incremental fair value under ASC 718-20-35-3 lands near zero.
Moderna’s late-2025 program is the fully documented version. Stockholders approved it at a special meeting on November 12, 2025, the offer ran November 13 to December 12, 2025, and 2,865 eligible holders participated. The company accepted options over 4,328,461 shares, 79.9% of the shares underlying eligible options, and granted replacements over 1,668,237 shares at $29.46 per the Schedule TO-I/A. Roughly 2.6 old shares surrendered for 1 new one.
Some programs swap options for restricted stock units, which hold value at any price but create a withholding problem at vest for a private company.
The exchange window is narrower than it looks
Rule 13e-4 doesn’t reach a private company, because 13e-4(a)(1) limits it to Section 12 registrants, Section 15(d) filers, and registered closed-end funds. That isn’t the end of the analysis. Rule 14e-1 sits under Exchange Act Section 14(e) and reaches any tender offer, so a private-company exchange with an employee election is one, and 14e-1(a) bars holding it open “for less than twenty business days.”
Now the ceiling. Under 26 CFR 1.424-1(e)(4)(iii), an offer to change option terms that stays outstanding for 30 days or more modifies the option as of the offer date, including every eligible incentive stock option held by employees who decline. Twenty business days is roughly 28 calendar days, so the compliant window is narrow by construction. Run the offer for 35 days to be generous and you silently convert ISOs for people who never participated.
Cancel and regrant, and the six-months-and-a-day convention
Waiting six months and a day between cancellation and regrant is superseded practitioner convention, not a rule in ASC 718. It descends from FASB Interpretation No. 44 under APB Opinion No. 25, which treated a lower-priced grant within six months of cancelling a higher-priced one as an indirect repricing and triggered variable accounting. That regime ended with ASC 718.
Current GAAP has no bright line. ASC 718-20-35-8 captures a cancellation accompanied by the concurrent grant of, or offer to grant, a replacement award, and the test is concurrency plus whether the employee would view the new award as a replacement. An announcement or a documented plan links the two events regardless of the calendar gap.
There is no waiting period.
The gap also costs you twice. The people you’re retaining hold no option at all in the meantime, and 26 CFR 1.422-4(b)(5)(ii) keeps the cancelled option counted against the holder’s $100,000 bucket “until the end of the calendar year during which it would otherwise have become exercisable for the first time.” So a February cancellation and an August regrant stack, and the excess becomes nonqualified.
The Accounting and Tax Consequences of a Reprice
A reprice is a modification under ASC 718-20, and it creates incremental compensation cost measured on the modification date. That cost is the excess, if any, of the modified award’s fair value over the original award’s fair value immediately before the change.
So you need two fair value computations, both as of the modification date, one with the old strike and one with the new. The option-pricing inputs are identical across the runs. Only the strike moves. SEC staff correspondence quoting the paragraph describes it as the repurchase of the original award by issuing a new one of equal or greater value, with additional cost for any incremental value.
For a private company the asset price input is the refreshed 409A common fair market value, so the valuation and the modification computation share a dependency. Run them at two firms on two assumption sets and the charge ends up disagreeing with the valuation report inside the same audit file.
Incremental value on the already-vested portion hits immediately. The unvested portion spreads over the remaining vesting period alongside the unrecognized original grant-date fair value. So the shape of the charge matters more than the size, and moving the reprice across a quarter boundary moves the immediate piece into a different reporting period. Model that before the board picks an effective date.
The ISO consequences, in the order they get missed
- The $100,000 limitation is retested. IRC 422(d) caps the aggregate fair market value of stock, measured at grant date under 26 CFR 1.422-4(b)(2), with respect to which ISOs are first exercisable in any calendar year. The repriced option is a new grant, so the test runs again, with the modified option still counted on its original terms through year end.
- The holding period clock restarts. IRC 422(a)(1) requires no disposition within two years from grant and one year after transfer, and the two-year clock now runs from the repricing date.
- The plan’s 10-year grant window may be closed. 26 CFR 1.422-2(c) requires an ISO to be granted within 10 years of plan adoption or stockholder approval, so replacements deemed granted under an older plan can’t be ISOs.
Set the new strike below the new fair market value and 1.409A-1(b)(5)(i)(A)(1) fails, which makes the repriced option nonqualified deferred compensation. The employee then owes income inclusion, premium interest at the underpayment rate plus one percentage point, and an additional 20 percent of the amount included. Our piece on IRS Section 409A penalties walks that stack. A reprice struck at exactly the new fair market value produces none of it.
SAS 143, codified at AU-C 540, names share-based payments among the estimates in scope, so your auditor will test the method, the assumptions, and the data behind both the refreshed 409A and the modification fair value. Write the memo the same week as the board resolution. See audit preparation for the rest of the file.
Deciding Whether to Reprice, Exchange, or Wait
Four variables decide this, and they can be assessed in one meeting.
- Remaining pool. Headroom makes additional grants the cheapest path administratively. Without it you’re choosing between a reprice, an exchange, and a pool increase that goes to the stockholders. An exchange is the only path that returns shares to the pool, because cancelling 2.6 shares to issue 1 creates headroom while fixing the problem.
- Retention risk, named. The question isn’t whether morale is down. It’s which specific people would be hard to replace inside 90 days. A reprice justified by a named list of twelve people reads very differently to an investor director than one justified by a sentiment survey.
- Burn and runway. A reprice costs no cash. It costs non-cash ASC 718 expense, and it costs preferred holders dilution-equivalent value. That makes it the available lever for a company with tight runway, which is often exactly the company that just priced down.
- Audit timing. Taking the reprice and the down round in the same audited period means one valuation report, one modification memo, and one set of assumptions for the auditor to test.
The working sequence: close the round, engage the refreshed 409A with the full capital structure in hand, freeze grants until the report is final, then model all three paths against the new fair market value. For each, compute the incremental fair value, the immediate versus deferred split, the $100,000 retest for your top 20 holders, and the pool impact.
None of this is venture-specific. A PE-backed company that recapitalizes, a bootstrapped company issuing a new preferred class to a strategic investor, and an owner-operated business resetting its equity plan after a bad year all run the same analysis and the same modification math. The regulations don’t ask who funded you. For entity-level context, see C-corp vs S-corp.
How Indinero Works Through a Post-Down-Round 409A
At indinero, the refreshed 409A, the ASC 718 modification charge, and the board package are one piece of work, not three separate engagements. That matters more here than on a routine refresh, because the three outputs have to agree with each other.
The valuation sets the fair market value. The modification computation uses that same number as its asset price input. The board package and the audit file carry both, with the same assumptions and the same dates. Split that across three vendors and the failure mode isn’t that any one of them is wrong. It’s that the charge was computed off a different number than the resolution relied on, and the gap surfaces six months later in the audit.
Bookkeeping, accounting, tax, and fractional CFO bundled under one monthly engagement means the number is set once and used everywhere. Continuous operations since 2009, 500+ regular customers.
Modification accounting is a judgment, not a formula. Two option-pricing runs as of the modification date, a vested and unvested split, a recognition period, and a memo an auditor can test under AU-C 540. A CPA team that works in GAAP writes that memo in the week of the board resolution.
The down-round framing is venture-shaped. The mechanics aren’t. Indinero works across PE-backed recapitalizations, strategic minority investments into bootstrapped companies, and plain equity plan resets, not only the venture path. Our 409A valuation services page covers scope, the essential guide to 409A valuations covers the full spine, and 409A valuation cost in 2026 covers what the work runs.
If your round just priced and nobody owns the sequence from valuation to memo, that’s worth a conversation before the next board meeting.
Frequently asked questions
Three questions come up in every post-down-round board conversation, and they’re worth settling before the reprice analysis starts. Short answers below, each with the regulation or codification reference behind it.
Does a down round automatically lower our 409A valuation?
No, a down round requires a new 409A valuation but doesn’t automatically produce a lower common fair market value. Common value is an allocation output, so a backsolve to the lower preferred price usually pulls it down, and a bigger liquidation preference stack pushes it further. A cram-down recapitalization that converts preferred to common can move common up instead. Indinero scopes a refreshed 409A with the full preference stack and recapitalization terms in hand, because those are inputs and not footnotes.
Do we need shareholder approval to reprice underwater options?
Whether repricing underwater options needs shareholder approval depends on your equity plan’s terms, not on a single universal rule. Many plans require it, and investor rights, voting, and credit agreements can add their own. Give holders an election instead of a uniform strike cut and the offer becomes a tender offer under Rule 14e-1, which has to stay open 20 business days. Board action and documented plan authority come first either way, and at indinero that analysis sits in the same file as the refreshed 409A.
Will repricing create new stock comp expense under ASC 718?
Yes, repricing is a modification under ASC 718, and any incremental fair value on the modification date becomes additional compensation cost. Incremental value is the excess of the modified award’s fair value over the original award’s fair value immediately before the change, measured with two option-pricing runs. The vested portion hits immediately, the rest spreads over the remaining vesting period, and original grant-date expense keeps running either way. Indinero computes the modification charge off the same refreshed 409A fair market value the board resolution relied on.
