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Should the FMV calculated as per 409A be adjusted for dilution to determine the exercise price for ESOP

I ran into this same question when we were setting up our ESOP, and here's what I learned.

The 409A valuation already takes dilution into account when it determines the fair market value (FMV) of your common stock. You do not need to, and really should not, make additional adjustments for dilution when setting the exercise price for options.

The valuation firm includes dilution assumptions in their model. Things like the size of the option pool, preferred share preferences, and any recent fundraising are already factored into the FMV. The IRS requirement is that the exercise price must be at or above the FMV of the common stock on the date of the grant, based on the 409A valuation.

In short:

• Use the FMV directly from your 409A report.

• Do not manually adjust it for dilution, since that can create compliance issues.

That is the approach most companies I have talked to use as well.