Many startup employees are unfamiliar with Rule 701 of the Securities Act. But if you’re a private company employee holding equity compensation, it should be on your radar. Rule 701 can help you obtain information to better understand your equity awards and inform your decisions, like whether to exercise your stock options. Private companies are notoriously secretive about their financial performance, making it difficult to understand the value of equity grants. Under Rule 701 of the Securities Act, you may have a right to more information than you realize.
What is Rule 701?
Private companies that rely on the registration exemption in Rule 701 of the Securities Act when granting or selling compensatory equity awards, like stock options, RSUs, and restricted stock, must provide certain disclosures if they sell more than $10 million of securities in reliance on the exemption in a 12-month period. Many private companies rely on Rule 701 to exempt equity grants from registration, and many late-stage companies exceed the $10 million threshold above which they’re required to provide these additional disclosures, which can include important details concerning the financial health of the company.
701 disclosures must include a copy of the company’s compensatory plan, risk factors related to an investment in the company’s securities, and financial statements of the company dated no more than 180 days prior to the sale. The disclosures must be provided within a reasonable period prior to the sale or exercise of stock options. This type of information can be hard for employees to find elsewhere. Financial statements can be particularly difficult to obtain from tight-lipped companies, and risk factors can provide useful insight into the risks and challenges faced by the company.
How can Rule 701 help you make better decisions about your options?
Why should equity holders know or care about this? Rule 701 disclosures may provide a clearer image of how the company is performing and the risks of investing in the company’s securities, which can help equity holders develop an educated view of how the company may fare in the future. These insights can help employees think strategically when deciding if and when to exercise stock options.
Some companies are reluctant to share this information, even when it’s a legal requirement. You may have to proactively communicate with the company’s HR, legal, or finance teams to obtain 701 disclosures. If a company doesn’t rely on the Rule 701 exemption, or issues less than $10 million in securities in reliance on the exemption in a given 12-month period, it won’t need to provide these disclosures.
These days, many employees have seen the worth of their equity decline with lower valuations and a dry IPO market. Many employees joined private companies with the expectation of a big return following an IPO or company acquisition, but are now unsure about the long-term prospects of the company they bought into. A large number of private company employees have recently been laid off and may find that they need to decide whether to exercise stock options in a short timeframe. For employees trying to understand a company’s prospects and health, 701 disclosures can offer more information than a 409A valuation, which is a single number indicating the fair market value of the company’s common shares, an indicator that reflects the current value and is often calculated conservatively. The additional information provided in 701 disclosures can prove useful to option-holders, whether recently laid off, planning a potential company departure, or simply trying to determine when it might be the ideal time to exercise.
How do I access 701 disclosures at my company?
Many companies will share 701 disclosures via equity portals like Carta or Shareworks, or on other password-protected sites. Other companies may only provide physical copies for viewing in the office or use other protected means to disclose information. If you can’t find this information through your equity portal or existing resources, your company may not be required to provide these disclosures or may have failed to compile or share the information. This could be a business decision or an oversight. But in many cases, it’s your right to receive these disclosures, and it may be wise to request them if they’re not already available.
Despite legal obligations, some companies may only share this information upon request. Many private companies are conscious of leaks and cautious about sharing financial information broadly. However, there are legal risks for companies that are not compliant with 701 disclosure obligations. Companies may be fined if they cross the $10 million threshold and don’t provide the required disclosures. For example, Credit Karma agreed to a fine of $160,000 for failing to comply with the disclosure requirements of Rule 701.
So, now that you know all about Rule 701, what’s next?
By knowing what to expect as a holder of compensatory equity in a private company relying on the Rule 701 exemption, you can make more informed decisions about your equity that can help you achieve better outcomes. If you have access to 701 disclosures, make sure to review the materials thoroughly, and consult with your financial and tax advisors before taking action regarding your equity.
For equity holders who decide to exercise options, Liquid Stock can help by providing the liquidity needed to cover exercise costs. And if you already own stock and want to obtain liquidity for your equity now without giving up your shares (which may be the case if you anticipate further growth and upside for the company), Liquid Stock can provide liquidity without a share sale.
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