Under securities laws, every issuance of securities is illegal unless you have an exemption. There are a number of exemptions with various criteria, and as long as an issuance fits into one, they are exempt. The SEC is busy and rarely will take enforcement action on small startups doing ordinary course activities. However, if the SEC does take action, the cost of the fee is significant.
Rule 701 is an exemption created by the SEC, which allows companies (that fall within certain thresholds) to issue equity compensation without the time and expense of registering the securities under the Securities Act. This rule is designed to protect stakeholders interest (e.g., stakeholder own a ton of the company, but the company won't share financial data).
In order to rely on the exemption provided by Rule 701, the greatest of the following must be true:
The aggregate sales price sold under Rule 701 is less than $1 million
The aggregate sales price sold under 701 is less than 15% of the total assets of the issuer, measured as of the date of the issuer’s most recent balance sheet; or
The number of securities sold under Rule 701 is less than 15% of the outstanding amount of the common shares, measured as of the date of the issuer’s most recent balance sheet.
How do I check if the equity compensation my company has issued is exempt under Rule 701?
Pulley has a Rule 701 calculator that runs the tests listed above to check if your company qualifies for Rule 701 exception.
Select Compliance > Rule 701 in the left-hand taskbar on Pulley.
Here are some things to note when using Pulley to check for Rule 701 compliance:
Options and RSAs recorded on Pulley without a specified federal exemption are assumed to be exempt under Rule 701. If this is not the case, change the federal exemption on the security profile page.
Securities recorded on Pulley without an issue date are not included in the Rule 701 calculations for aggregate sales price or number of securities sold under Rule 701. To add an issue date, please go to the security profile page.
Pulley defines the value of the RSA as price per share multiplied by quantity. Consult a tax advisor to confirm the value of RSAs issued under Rule 701.
Pulley's Rule 701 calculation assumes your company only has 1 class of common shares. If you have multiple classes of common shares, reach out to email@example.com.
Pulley does not include canceled option grants in our Rule 701 check.
What information do I need to test if the equity compensation my company is issuing is exempt under Rule 701?
Reporting Year End: Most companies align the 12-month period to their fiscal year, but you can also use rolling 12 months. Once you decide between the two options, you must remain consistent. If your company is issuing a lot of securities at a certain time of year, it may make sense to structure the 12-months, so the large batch of securities is split across two periods. This could help you avoid the additional disclosure requirements for companies issuing more than $10 million of Rule 701 securities in 12 months.
Total Assets: This should be from the most recent balance sheet (no older than last FY end). You may not need to input this information if you “pass” one of the other two tests (i.e., if your aggregate sales price is less than $1 million or if the number of securities sold under Rule 01 is less than 15% of the outstanding number of common shares).
Issue Dates: All the securities associated with Rule 701 should have their issue dates correctly recorded out in Pulley. Securities with missing issue dates will not be included in the calculation and could cause an incorrect result. To add an issue date, please go to the security page.
Federal Exemptions: Options and RSAs recorded in Pulley without a federal exemption are assumed to be exempt under Rule 701. If this is not the case, change the federal exemption on the security profile page.
The equity compensation that my company has issued is exempt under Rule 701. Now what?
If your company expects that the total aggregate sales price sold under Rule 701 issued during the 12 months will exceed $10 million, then Rule 701 requires the company to provide certain information to the recipients of equity compensation so that the stock option holders can make an informed decision before exercising.
A summary of the material terms of the employee benefit plan;
The risks associated with the investment; and
GAAP compliant financial statements, including the latest balance sheet and the statements of income, cash flows, and capitalization for the preceding two fiscal years.
DISCLAIMER: The information contained in the Site is general legal information and should not be construed as legal advice to be applied to any specific factual situation