Generally, it is unlawful to sell securities unless they are the subject of an effective registration statement and, in most states unless, qualified under their securities laws, unless in either case the transaction or the security is exempt.  An earlier post discussed sales of securities to friends and family and the dangers of running afoul of federal and states’ securities laws.

The start up venture will infrequently have sufficient funds to adequately compensate, officers, directors, consultants and employees.  Issuance of stock or options to purchase stock are an easy and inexpensive way to increase such compensation.  How difficult is it to issue officers,  directors, consultants and employees options or stock within the confines of federal and state securities laws?

SEC Rule 701 offers a safe, direct and simple way to do this.  That rule permits nonpublic companies to issue their securities to, among others, employees, officers, directors and some consultants, under a written benefit plan or compensation contract, without registration, and without filings, if the requirements of the rule are met.  The rule is non exclusive and the Company may claim any other exemption from the registration requirements of the Securities Act of 1933.

First, the total sales price of securities sold under Rule 701 during any consecutive 12 month period can’t exceed the greatest of the following:

a    $1 Million,

b    15% of the total assets of the company, measured at the company’s most recent balance sheet date (if no older than its last fiscal year end), or

c    15% of the outstanding amount of the class of securities being offered and sold in reliance of Rule 701, again measured at the company’s most recent balance sheet date (if no older than its last fiscal year end).

Sales of securities underlying options must be counted as sales on the date of option grant.

Second, the Company must deliver to the investor a copy of the benefit plan or compensation contract.  The preliminary notes to the rule, however, state that the Company and those acting on its behalf  “have an obligation to provide investors with disclosure adequate to satisfy the antifraud provisions of the federal securities laws.”  This is a little tricky and any such disclosure beyond the mere delivery of the plan or contract depends upon the Company and the composition of the proposed sales under Rule 701.

If the aggregate price of securities sold exceed $5 Million during any consecutive 12 month period, the Company must make further disclosures.  For example risk factors, and plan and financial information must be provided.

There are restrictions on transfer of the shares sold under Rule 701.

Not all consultants or advisers may be granted shares or options under the rule. There are restrictions as to which persons may be granted shares or options.

State securities laws should be checked.  By regulation, Massachusetts has a self-executing exemption for shares issued pursuant to Rule 701.

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