Down-Round 409A: Why Common Falls More Than Preferred
A post-down-round 409A is the OPM-backed common price after anti-dilution, not the preferred price. Grants must follow it to avoid 409A penalties.
Your post-down-round 409A just came back, and the common price is far below the new preferred price. The trap is treating the preferred price as the common price; the rule is to use the OPM-backed common fair market value after anti-dilution.
In a severe down round, the new preferred price can be 40% to 70% below the last round, and the common fair market value per share can end up at only 5% to 15% of the new preferred price. A strike above that common value can leave the grant underwater; a strike below it can point to a repricing or a 409A problem.
The preferred price anchors the model, not the common price
The new preferred price is the market signal the company just accepted. It is lower than the last round, but it applies to preferred shares, not common stock.
For most post-down-round analyses, the team uses backsolve to anchor the OPM allocation across security classes from the new preferred price. OPM is the option-pricing model that splits an implied enterprise value, the value of the whole company, among preferred, common, options, and other claims. The common slice is what remains after the senior claims are paid.
Common can fall farther than preferred because the new investors buy preferred at a lower price, and the model works backward from that price. Common holders are junior, so the drop hits them hardest.
Anti-dilution decides how far common falls
Anti-dilution adjustments are the contractual fixes that shift value from existing holders to the new investors when the new round prices lower. If the OPM model leaves them out, it overstates common stock fair market value.
The size of the drop depends on the protection in the preferred stock. Full-ratchet protection can shave 15% to 25% of founder ownership in a single recapitalization, whereas broad-based weighted-average protection usually limits the founder hit to under 10%. A post-down-round valuation can look far below the preferred price without being an error.
Grants and repricings must follow the new common price
The option strike is the number to compare against the new common fair market value. A strike above that value leaves the holder needing a new grant or a repricing to get back in the money.
Repricing can reset existing option strikes to the new fair market value, often with a fresh 409A valuation behind it. In the first quarter of 2024, 184 companies repriced roughly 19,000 older option grants. That pattern shows repricing is not exotic after a down round; it is a cap table correction when the old strike no longer matches the new common value.
If the company grants options after the round closes but before the new 409A valuation is finished, the grant can be discounted, meaning the strike is below fair market value, and trigger tax penalties under IRC Section 409A for the holder, not the company. The safe move is to wait for the new common fair market value before setting a strike. When a grant must happen before the valuation is finished, the company needs a clear plan to fix any gap.
Run a four-step check before you panic
- Start with the new preferred price and confirm it is the post-down-round price, not the last round price.
- Backsolve enterprise value with OPM, using that preferred price as the anchor.
- Apply anti-dilution adjustments before you read the common stock fair market value.
- Confirm the grant uses the new common fair market value, not the old strike, and flag any gap.
Work through the check in order. A new common FMV below your strike calls for a repricing or a new grant. Above your strike, the option is not underwater, but confirm the grant used the new number.
