The Advisors' Blog

This Cooley blog discusses what private companies need to know about Rule 701, a key rule for private company executive compensation programs that, unfortunately, is responsible for a fair number of foot faults often uncovered during one of the most inopportune times (the IPO process) as counsel diligences past equity grants. The SEC has also been known to conduct periodic audits and assess fines for noncompliance.

Rule 701 is the primary US federal securities law exemption for offers and sales of compensatory awards – e.g., options, restricted stock awards (RSAs), restricted stock units (RSUs), etc. – by a private company to its employees, directors, officers, consultants, advisers, and other individuals providing bona fide services to the company (or any of its subsidiaries), that are issued pursuant to a compensatory benefits plan such as an equity incentive plan.

The availability of Rule 701 comes with certain quantitative limits. Early-stage companies usually operate well within these limits. However, later-stage private companies should understand the limits of the exemption and start monitoring before additional requirements kick in to avoid inadvertently failing to comply with Rule 701.

The blog then breaks down in Q&A format some of the trickiest parts of Rule 701 — particularly for larger and later-stage private companies — including the rule’s quantitative limits.

To rely on Rule 701, the aggregate sales price of securities offered and sold during a 12-month period using this exemption must be at least one of the following:

• Less than $1 million in total value.
• Less than 15% of the total assets of the issuer (as of the most recent balance sheet date).
• Less than 15% of the outstanding amount of the class of securities being offered and sold (as of the most recent balance sheet date).

Note: The 12-month period can begin on any date during the calendar year – it does not need to be tied to the calendar year or the company’s fiscal year. However, once you select a date, you must stick to that date for future analyses. Aggregate sales price means the sum of all cash, property, notes, cancellation of debt, or other consideration received or to be received by the issuer for the sale of the securities.

While compliance should be monitored continuously, the blog points to these factors indicating it’s time for a more detailed analysis:

– You have a high 409A valuation.
– Your company’s valuation is approaching $1 billion.
– Your board is regularly approving large option grant packages or is hiring one or more senior executives.
– You are hiring aggressively and/or making a large number of “refresh” grants.
– You begin issuing RSUs.
– You have conducted a repricing of your outstanding stock options recently.

– Meredith Ervine