Rule 701 is a federal securities law exemption that lets companies grant employees, independent contractors, and others equity in accordance with a company stock (or token) incentive plan.
One key thing to remember when relying on Rule 701 is that employees, consultants, and advisors can receive compensatory equity incentives so long as they are natural persons that provide bona fide services to the company and/or its related businesses (such as any majority-owned subsidiaries).
These individuals can be located anywhere in the world (excluding embargoed or sanctioned countries). There will be, however, differing tax requirements depending on whether an individual is:
- a US-based employee,
- a US-based independent contractor,
- a non-US-based employee, or
- a non-US-based independent contractor.
One important caveat is that these individuals cannot be involved in the offer or sale of securities in a capital-raising transaction; similarly, they must not promote or maintain a market for the company’s securities. Put more plainly, under Rule 701 you can’t compensate someone whose contribution to the company is introducing you to investors. (In general, you shouldn’t compensate people for investor introductions unless they are registered broker-dealers.)
Because the rule specifically applies only to natural persons, a consultant billing for services via an LLC cannot receive equity compensation in the name of that LLC. To do so, a company would need to rely on a different securities law exemption, such as Rule 506(b). If you do that, of course, it would mean needing to be in compliance with the requirements associated with that particular exemption.
Do note that Rule 701 is currently under review, with the SEC having proposed changes in late 2020 that would impact gig workers, the asset cap, age of financial statements, and potentially the treatment of consultants and advisors. Make sure to check regularly for any finalized changes.
