A board asked to waive the company’s right of first refusal so the round’s lead can buy common from the founder at the preferred price is also setting part of the strike price on the next option grants. The founder gets cash and the lead gets ownership. Whoever is granted options after the sale, whether a new hire or an employee getting a refresh grant, absorbs whatever the sale adds to the common valuation, and none of those people is in the room.
The constraint comes from the section 409A regulations. A nonqualified option stays outside section 409A only if its exercise price can never be less than the stock’s fair market value on the grant date. For private stock, that value has to come from reasonably applying a reasonable valuation method, and the factors the regulation lists include recent arm’s length sales of the stock. A value calculated earlier stops being reasonable once it fails to reflect later information that may materially affect value, or once it is more than 12 months old, so a valuation dated before the sale may not support grants made after it. Ignoring the sale shifts the risk onto the same employees. If an option fails the exemption and also fails section 409A’s requirements, the holder must include the deferred amount in income to the extent it has vested, and owes an additional 20 percent tax plus premium interest set one point above the underpayment rate.
The regulation lists factors without weights, so how far the sale moves the value is the appraiser’s judgment. Carta’s valuation team, which sells these appraisals, argued in January 2023 that for 409A purposes appraisers give more weight to a secondary that covers a large share of the company, recurs, involves many buyers and sellers and gives them equal information, and less to one that is small, one-off and between a few parties. The authors wrote that a recent secondary price might by then account for about half of a combined 409A and accounting valuation, against perhaps 5 percent a decade earlier, and recommended separating the two valuations so the 409A could weigh each secondary on those characteristics.
Applied to this sale, those factors point toward a low weight: one seller, one buyer, one transaction. Against that, both sides are about as informed as anyone can be: the founder runs the company, and the buyer has just finished its diligence for the round. What the price measures is a separate question. If the lead paid the preferred price for common to secure its allocation, the price says more about the round than about common, which goes to whether the sale is arm’s length evidence about common at all. The board knows which description fits. The appraiser knows only what it is told.
Take an illustrative company whose appraiser would value common at $3.00 on the round alone, with preferred at $10.00, and treat the appraisal as a simple weighted average of those two prices. Real appraisals blend several methods and apply discounts, so the average shows only magnitude. A 5 percent weight on the founder sale gives $3.35, 15 percent gives $4.05, and 50 percent gives $6.50. Suppose the company then grants 600,000 options and is later sold for enough that the preferred converts, with options cashed out for their spread and their exercise prices added to the purchase price before it is divided over 20 million fully diluted shares. Each extra dollar of strike moves about $582,000 from those option holders to everyone else: their aggregate exercise price rises by $600,000, and they get back only 3 percent of it through the higher per-share price. Where a $3.00 strike would leave $9.00 of spread per option, a $4.00 strike leaves about $8.03, roughly 11 percent less. At $27.00 of spread the cut is under 4 percent, so the transfer weighs most on a modest exit.
A fair objection is that a higher strike is simply accurate. If the appraiser counts the sale, common is worth more, and later hires get options priced at fair market value like anyone else. That holds to the extent the sale says something about common, and less when the price was part of buying the round. A second objection is that founder liquidity can be worth its cost to the company. The board may well conclude that; it should do so with the cost written down.
Fairness to current employees pulls against the strike price. Opening the sale to employees spreads the liquidity, but it also makes the transaction larger and more widely held, which by Carta’s account is the kind of secondary appraisers weight more heavily. A board can reasonably make that trade, but it is choosing liquidity for current holders at the price of higher strikes for later ones.
Before waiving the right of first refusal, I would give the appraiser a full account of how the price was set, ask for common values with and without the sale, and put the founder’s proceeds beside the modeled change in later option holders’ exit value in the approval memo.