When preferred stock investors calculate the value of a company, they do so with reference to a cap table showing the fully diluted capitalization of the company (that is, all classes of stock plus options) assuming that all stock is converted to common and all options exercised.

In this way, a lead investor investing, say, $4M in an A round with a $6M pre-money company valuation and paying $1/sh against a model of 10M authorized would own 40% of a $10M company (post-money valuation), would own 4M shares of Series A preferred stock valued at $1/sh, and would do so in a context where there may be, say, 4M common shares held by founders and 2M common shares held in a pool for equity incentives. When that same company goes to do its 409A valuation following that preferred round, it retains an outside independent valuation company to calculate the price of its common stock for purposes of valuing options granted to employees (409A is solely designed as a compliance provision requiring that options and other forms of deferred compensation granted to executives and other employees not be underpriced as of the date of grant). When it does that valuation, the outside company will measure the value of the common stock by looking at the arms-length deal done by the Series A investors by which they paid $1/sh that gave them each 1 share of preferred stock that is typically convertible 1:1 into common stock on the happening of certain events. As of the date of the Series A investment, that common stock clearly does not have the same value as the preferred stock because the preferred stock includes a series of valuable preferences that the common stock lacks (e.g., a liquidation preference giving it first preference in being paid the proceeds of any acquisition, subject to various limitations; a right to class approval of major corporate actions; a right to anti-dilution protection in the event of a down round, etc.). Any common stockholder who has been "wiped out" in a merger where the preferred holders take everything and the common holders get nothing can attest to the value of these preferences. This is why the stock is called "preferred" in the first place. In any case, in the days before 409A, a company's board of directors would routinely use a 10:1 ratio to value the preferred stock in relation to the common owing to the value of the preferences (that is, in our example above, the preferred stock would be priced at $1/sh and the common at $.10/sh). Since the enactment of 409A, that ratio has shrunk considerably and, today, the outside companies who do the valuations will at their most aggressive use a 5:1 ratio and will much more typically use more like a 3:1 ratio in accounting for the valuation difference (again, in our example, resulting in common stock prices of $.20/sh and $.33/sh respectively). The common stock valuation so determined will then be used by the company for valuing its stock options granted to employees. After such options are granted, should the company hit the skids and go down (or get acquired in a fire sale), the common stock holders would typically get nothing while the preferred holders may get some or all of their money back. On the other hand, if the company does very well and is ultimately acquired at a premium, then the preferred holders (in a typical case where the preferred stock is non-participating and only gets its money back on the liquidation preference without participating in any further payout) will convert to common in order to get the benefits of the acquisition and will share equally (in accordance with their percentage interest in the company) with all other common holders in those proceeds. In this way, in the end, the discounted value of the common stock as used for 409A purposes becomes irrelevant to the value of the company and what really counts is the arms-length price that someone will pay for the acquisition, as to which the common will share equally with the preferred. In other words, there was a reason for discounting the value of the common at the time of the A round but that reason goes away once the acquisition occurs and that event in turn establishes the pricing for common stock at the new premium price without regard to what the 409A price was in different circumstances.

This is why it is legitimate for company valuations to be based on the latest preferred pricing spread against the fully diluted capitalization of the company. It is not inconsistent to use that approach for the overall valuation of the company while using a discounted approach for 409A purposes. They are two different measures, each used for a distinct purpose, and are quite compatible with one another.

Hope this helps explain the technical points involved.