If you are a non-public company granting stock options or other compensatory equity awards, you need to be familiar with Rule 701 Math and in particular its mathematical limitations.
Fortunately, they are pretty simple.
Unfortunately, many entrepreneurs overlook them with sometimes disastrous consequences.
To save you some time, we wrote you a step-by-step guide to make you’re complying with the rule and not running afoul of the SEC.
Step One
Multiply your company’s total assets as of the most recent annual balance sheet date by .15.
Step Two
Multiply the outstanding number of shares of the same class being offered, not counting any securities issued under 701, by .15. This will be common stock, any warrants, and more than likely preferred stock because it is convertible into common stock at any time. Check the cap table for this info. If there’s no updated cap table, take a look at your company’s most recent offering’s reps and warranties.
Step Three
Compare $1,000,000, #2, and #3. Select the largest figure. If you are early-stage, it is likely $1M. If you’re growing, it is likely #2. If you’re a mature company, it is likely #1.
Step Four
Tally up the number of compensatory options and shares your Company has issued within the last twelve months from the time you are planning on issuing the new option/shares compensatory awards.
Step Five
Add #4 to the number of options/shares compensatory awards you are planning on issuing.
Step Six
Make sure that #5 is less than or equal to #3.
This is just the 701 math component of Rule 701’s limits and qualifications. Don’t forget to comply with its other provisions. Be sure to go through this step-by-step process before you issue any stock options.
By: Joe Wallin and James Graves
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