Setting the strike price: US 409A and Indian valuations by a merchant banker

1. The core idea#

The strike price (exercise price) is what an employee pays per share to turn an option into a share. The lower it is relative to the share's eventual value, the more the option is worth. But strike prices are not freely chosen. Each country links them to an official "fair market value" (FMV), and getting it wrong creates tax problems for employees and the company.

• US: options must be granted at or above the FMV of common stock, set by a 409A valuation, usually by an independent appraiser. Common stock is valued well below the preferred price investors paid, because preferred shares have liquidation preferences and other rights. So employees typically get options at a large discount to the last round's price, legally.
• India: there is no legal floor on the exercise price, and many Indian startups set it at face value (₹1 or ₹10). But tax is charged at exercise on the difference between FMV and the price paid, and for unlisted shares that FMV must come from a SEBIregistered Category I merchant banker, in a report no more than 180 days old. The real design question in India is the perquisite tax at exercise, not the strike price.
• UK: EMI options can have any strike price, but if it is below market value, the discount is taxed at exercise. Companies usually agree a valuation with HMRC first.

For founders, the practical rules are: value before you grant, refresh after every priced round or material event, and keep the reports, because auditors, acquirers and tax authorities will ask for them.

Who this is for: founders about to grant options for the first time; anyone after a priced round, or before grants in several countries.

Pairs with: 5.02 (plan design), 5.08 (ESOP tax), 4.18 (compliance calendar) and 4.19 (FEMA pricing for foreign investors, which uses a separate valuation).

2. What the rules and evidence say#

US: 409A#

• The rule. Section 409A of the Internal Revenue Code taxes deferred compensation harshly unless it meets strict conditions. Options granted at or above FMV are exempt. Options granted below FMV are treated as deferred compensation: the
• employee can owe income tax as the options vest, plus an extra 20% tax and interest. Safe harbours. The regulations give a presumption that a valuation is reasonable if it uses an independent appraisal no more than 12 months old (with no material change since), or, for startups under 10 years old with no expected sale or IPO soon, a written valuation by someone with significant relevant experience. In practice almost all venture-backed companies buy an independent 409A.
• How the number is reached. Appraisers estimate the company's enterprise value, usually by back-solving from the latest preferred price for early-stage companies, allocate it across share classes, and apply a discount for lack of marketability. Common therefore lands well below preferred.
• Typical ratios. Practitioner guides put common at roughly 10–25% of the preferred price at seed, 25–40% at Series A, and climbing towards 75–95% just before an IPO. More layers of preference above the common push the ratio lower.
• Cost. A standalone 409A from platform providers typically costs about $1,000–3,500 at pre-seed to Series B; complex capital structures cost more.

India: the merchant banker valuation#

• Strike price. The Companies Act and Rule 12 let the company set the exercise price, subject to its accounting policies. Many startups use face value or a low price.
• Tax FMV at exercise. The perquisite taxed as salary is FMV on the exercise date minus the price paid. For unlisted shares, FMV must be determined by a SEBIregistered Category I merchant banker on the exercise date or any date up to 180 days before it (Rule 3(8) of the 1962 Income-tax Rules). The Income-tax Act 2025 renumbers the provisions; the substance carries over into the 2026 rules.
• Several valuations, several purposes. An Indian startup typically needs: a merchant banker FMV for exercise-date tax; a registered valuer or merchant banker report for share issues to investors (Companies Act and FEMA pricing); and a fair value of the options for Ind AS 102 accounting expense. They use different methods and are not interchangeable.
• No 409A equivalent at grant. There is no penalty for a low strike price in India; the tax comes at exercise regardless. A very low strike price simply increases the taxable perquisite later.

UK: HMRC agreement#

• EMI options can be granted at any price. If the exercise price is below the actual market value (AMV) at grant, the discount is subject to income tax (and possibly National Insurance) at exercise. Granting at or above AMV means no income tax at exercise.
• Agreeing a value. Companies usually submit a valuation to HMRC's Shares and Assets Valuation team before granting EMI options, and grant within the period HMRC's agreement letter allows.
• Growth shares and unapproved options need their own valuation, often with a hurdle above current value.

3. The method#

Step 1: Know which valuations you need#

Step 2: Time the valuations#

• Before the first grant, and after every priced round. In the US, any grant made after a round but before a new 409A risks being below FMV.
• After material events: a large contract, a big technical milestone, a term sheet, an acquisition offer. These can make an old 409A unreliable even within 12 months.
• Batch grants so one valuation covers many. Approve grants in a single board meeting soon after each valuation.
• In India, plan exercise windows (for example quarterly) so one merchant banker report can cover all exercises within 180 days, and schedule a report before a buyback (5.10).

Step 3: Choose a provider#

Pick an appraiser that auditors and acquirers accept: in the US, firms that do many venture 409As; in India, a SEBI Category I merchant banker with startup experience; in the UK, an accountant experienced in HMRC EMI valuations. Ask about cost, turnaround (usually 1–3 weeks), and whether they will defend the valuation in an audit.

Step 4: Give the provider good inputs#

Cap table with every share class and its rights; the latest financing documents; financial statements and projections; recent material events. Deeptech specifics matter: technical risk, time to revenue, and how much capital is still needed all affect the discount.

Step 5: Record and explain#

Keep every report with the board minutes approving grants. Tell employees their strike price, the latest preferred price, and why they differ (5.11).

Worked example#

A US-parented battery company with an Indian subsidiary raises a seed round at $2.00 per preferred share.

• US 409A: two weeks after closing, an independent appraiser values common at $0.38 (19% of preferred), reflecting a 1x liquidation preference, early-stage technical risk and a marketability discount. The board grants options to 12 US and Indian employees at $0.38 the same week.

Six months later, the company signs a $3 million supply agreement with a carmaker. Counsel advises that this is a material event, so the company gets a new 409A at $0.61 before the next batch of grants.

• Indian employees: when four Indian employees exercise options in a buyback 18 months later, the Indian subsidiary obtains a merchant banker FMV of the parent's shares dated within 180 days of exercise, at $1.10. Each employee's perquisite is $1.10 minus $0.38 per share, taxed as salary in India with TDS by the subsidiary. The US 409A is not used for Indian tax.
• Records: the board minutes, 409A reports, merchant banker reports and option agreements go into the data room, and Series A diligence closes without valuation questions.

4. Country notes: India, US, UK#

India.

• Category I only. The merchant banker must be SEBI-registered in Category I; reports from other valuers are not valid for the exercise-date FMV.
• Strike price choices. Setting the strike at face value maximises the employee's eventual gain but also the perquisite tax at exercise. Setting it at the latest FMV reduces the tax but also the upside. Many companies choose face value or a deep discount, and help employees with tax through the DPIIT deferral or cashless exercise (5.08, 5.10).

• Accounting cost. A low strike price means a higher Ind AS 102 expense in the profit and loss account, which matters for companies reporting losses to investors or planning an IPO.

• Parent-company options held by Indian employees are taxed in India using an Indianrules FMV, not the parent's 409A. Get both valuations.
• Income-tax Act 2025. From tax year 2026–27, the perquisite and TDS provisions move to new section numbers (s.392 for salary TDS), and the valuation rules move into the 2026 Income-tax Rules. Practitioners agree the substance is unchanged.

US.

• Refresh triggers: at least every 12 months, after each priced round, and after material events. A term sheet signed but not closed is a material event for 409A purposes. ISOs must be granted at 100% of FMV (110% for 10%+ holders) to qualify.
• Secondary sales at prices above the 409A can affect the next valuation; appraisers will ask about them (5.20).
• Audit defence: a reputable independent 409A shifts the burden to the IRS to show the value was grossly unreasonable.

UK.

• HMRC valuation check: submit form VAL231 with a valuation report to HMRC's Shares and Assets Valuation team before granting EMI options. Check the period stated in HMRC's letter for how long the agreed value can be relied on, and grant within it.
• Actual and unrestricted market value: HMRC agrees both. For EMI, the AMV (taking into account restrictions on the shares) is usually what matters for income tax at exercise.
• The EMI limits (£250,000 per employee, £6 million company limit from April 2026) are measured using the agreed unrestricted market value at grant, so the valuation also determines how many options fit under the limits.

5. Scripts, mistakes, related playbooks, sources#

Scripts#

Explaining the strike price to a new hire (US):

"Investors paid $2.00 per preferred share in our seed round. Your options are over common shares, which an independent appraiser valued at $0.38, because preferred shares get paid first in a sale and have other rights. Your strike price is $0.38, so the gap is part of the value of joining now."

Explaining it in India:

"Your exercise price is ₹10 per share. When you exercise, tax is charged as salary on the difference between the share's value at that time, set by an independent merchant banker, and the ₹10 you pay. As an eligible startup, we can defer the tax deduction until you can sell, leave or a set period passes (5.08)."

Briefing a valuation provider:

"We need a [409A / merchant banker FMV / HMRC EMI valuation] as of [date], for grants planned in [weeks]. Attached are the cap table, financing documents, financials and projections, and a note on material events since our last valuation, including [contract, milestone, term sheet]."

Common mistakes#

1. Granting US options after a priced round but before a new 409A.
2. Ignoring material events, relying on an old 409A after a big contract or term sheet.
3. Using the 409A for Indian employees' tax, or the investor valuation for ESOP perquisites.
4. Using a non-Category I valuer in India.
5. Letting merchant banker reports expire before exercises, forcing a rushed new valuation.
6. Granting EMI options before HMRC agrees the value, or after the agreed period.
7. Setting a high strike price in India to avoid perquisite tax, which leaves employees with little upside.
8. No records, so diligence cannot verify strike prices.

Related playbooks#

• 4.18 Compliance calendar: ROC filings, annual returns, Delaware franchise tax
• 4.19 FEMA, FDI and ODI rules for foreign money
• 5.02 ESOP plan design: India (Companies Act rules) vs US (ISOs and NSOs)
• 5.08 ESOP tax: Indian perquisite tax and the deferral for DPIIT startups; US ISO and AMT
• 5.10 ESOP buybacks and liquidity programmes
• 5.11 Explaining equity to employees: offer letters and equity education

Sources#

• US: IRC s.409A and Treas. Reg. 1.409A-1(b)(5)(iv)(B) (valuation safe harbours); IRC s.422. Practitioner ranges for common-to-preferred ratios from Terms.law; cost estimates from VC Beast; method overview from CRV (March 2026).
• India: Income-tax Rules 1962, rule 3(8)–(9) (Income Tax Department guidance); summaries from EquityList and Treelife on the 2025 Act and 2026 Rules; Ind AS 102.
• UK: ITEPA 2003 Sch.5; HMRC Shares and Assets Valuation (form VAL231).