Compensatory Equity: Securities Law Considerations

Thank you to Lauren Hakala at Practical Law and to my colleauge Susan Schalla for writing the attached article with me.

Start-up Equity Awards Securities Law Considerations

In this article we go into the securities law issues companies have to confront before they issue compensatory equity awards to employees and service providers. Believe it or not, you can’t just issue your employees stock or stock options without first finding and complying with an applicable securities law exemption.

For stock option grants, this can mean filing forms and paying fees in various states in which you have employees. And on each option grant you also have to determine whether you have exceeded mathematical limitations imposed by the federal securities law. It is unfortunate that the law puts limitations on how easily you can share equity with workers. This doesn’t make sense, and Congress and/or the SEC ought to revisit the thinking that went into setting these limitations. Regardless, they exist today, and we have to comply with them.

What is Rule 701?

Rule 701 is the federal securities law exemption for stock options. It contains a number of limitations.For example:

  • You can only use Rule 701 to grant compensatory equity awards (as an incentive for services).
  • You can’t rely on Rule 701 to raise capital.
  • You can only make awards to individuals (no entities).
  • You are limited in the amount of equity you can grant in any 12-month period to the greater of one of three measures.
  • Despite compliance with federal law, you must still comply with state law (i.e., there is no federal preemption in this area).

How To Issue Compensatory Equity Awards Such as Options to Workers

I’ve written a blog post titled, Stock Option Grant Checklist, if you are interested in the mechanical steps required to technically and in compliance with law grant stock options.

I hope you enjoy the Practical Law article. 


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