What Is Rule 701? Definition, How It Works and Examples

The Securities Act of 1933 says every offer or sale of securities must be registered with the SEC unless an exemption applies. Registration means filing a full disclosure document, as in an IPO. A startup that pays people partly in stock cannot do that for every grant. Rule 701 is the exemption written for this case.

Two conditions frame it. The company must not file regular reports with the SEC, which describes nearly every private company. And the company must not be an investment fund registered, or required to register, under the Investment Company Act. A company that later becomes public may still complete grants it offered while it was private.

The rule covers the usual forms of equity compensation: stock options, both kinds compared in ISO vs NSO, restricted stock and RSUs. An RSU is a promise to deliver shares later.

The Rule 701 exemption is for compensation only. The rule says it may not be used to raise capital. Shares go to people who work for the company, its parent or a majority-owned subsidiary.

• Employees and officersIncluding directors, general partners and trustees of a business trust.
• Consultants and advisorsOnly natural persons who provide real services. Services tied to raising money or making a market in the shares do not qualify.
• Family membersOnly when they receive the shares from a holder by gift or under a domestic relations order, such as a divorce settlement.
• Former employeesOnly for offers made while they still worked for the company.

Rule 701 grants stand apart from the company’s other offerings. They are not combined with a funding round for any limit. A round under another exemption does not use up the Rule 701 cap either.

Why Rule 701 Is Only a Federal Exemption

Rule 701 is a federal exemption. It removes the need for SEC registration and nothing more. The rule itself says the company must still comply with state securities laws, and each state has its own. Fraud rules also keep applying. A company must tell recipients enough to meet the antifraud provisions, even below the disclosure line.

A company can offer any amount. The limit applies to sales in any 12 months in a row. Sales may not exceed the greatest of three tests, measured at the most recent balance sheet date.

The size cap and the disclosure line are separate tests. A company can stay within the cap and still cross $10 million. The worked example below shows both.

Rule 701 disclosure starts small. Every recipient must get a copy of the plan or the contract behind the grant. Above $10 million in sales in 12 months, the company must also give, a reasonable time before the sale, three more things.

1. 01
   Plan summaryThe summary plan description required by ERISA, the federal law on employee benefit plans, or a summary of the plan’s main terms if ERISA does not apply.
2. 02
   Risk factorsInformation about the risks of owning the shares.
3. 03
   Financial statementsPrepared to the standard of Regulation A, and dated no more than 180 days before the sale.

Timing follows the type of grant. For options, the disclosure must arrive a reasonable time before you exercise. SEC staff say that for RSUs it must come before the grant. The SEC staff interpretations add a hard edge. If a company expects to pass $10 million, everyone in that offering must get the disclosure. A company that misses it loses the exemption for the entire offering.

The line moved once. On July 18, 2018, the SEC raised it from $5 million to $10 million, as Congress had required that year.

Take a private company with $40M of total assets and 50,000,000 common shares on its latest balance sheet. Its three tests are $1M, $6M (15% of $40M) and 7,500,000 shares (15% of the class). The company grants options with an exercise price of $2.00. All figures are illustrative.

In Year 2 the grants fit under the share test, so the exemption holds. But sales of $12M pass the $10M line. Every option holder in that 12-month period must get the plan summary, risk factors and recent financial statements before exercising. If the company skips it, it loses the exemption for the whole Year 2 offering.

Rule 701 compliance is a running record more than a one-time filing. The rule itself has no SEC form. A company keeps track of four things.

• The capEvery grant, valued as the rule requires, against the three tests over the chosen 12-month window.
• The disclosure lineWhether sales will pass $10M, and whether everyone in the offering got the extra documents in time.
• Fresh financialsStatements older than 180 days have to be replaced before the next sale.
• State rulesEach state where a recipient lives can have its own requirements.

Shares you get under Rule 701 are restricted securities, shares from a private deal. You cannot sell them on a market until you meet Rule 144 or another exemption. While the company is private, that usually means a company-approved tender offer or a secondary sale.

The listing changes this. Ninety days after the company starts reporting to the SEC, employees who are not affiliates can sell under Rule 144 without its holding period or public-information test. Affiliates, such as directors and senior officers, skip the holding period but keep the volume cap and the other conditions.

In practice the IPO lock-up usually ends later, typically after 180 days. So the lock-up, set by contract, decides your first selling day more often than Rule 701 does.

• Counting options at exerciseAn option counts as sold on the grant date, at its exercise price. Exercises later do not count again.
• Reading the cap and the disclosure line as one testA company can be within the 15% cap and still owe the extra disclosure above $10M.
• Giving disclosure only to later recipientsOnce sales are expected to pass $10M, everyone in that offering needs it.
• Using Rule 701 to raise moneyThe rule is for compensation. Selling shares to staff as a funding round falls outside it.
• Forgetting state lawRule 701 is a federal exemption. State securities rules still apply.
• Assuming shares are free to sellThey are restricted. Before an IPO, resale needs another exemption and usually company approval.

Rule 701

The SEC exemption for equity that a private company grants as compensation.

Registration

Filing a disclosure document with the SEC before offering securities to the public.

Exemption

A rule that allows an offer or sale without registration if its conditions are met.

Reporting company

A company that files periodic reports with the SEC. Rule 701 is available only to companies that do not.

Aggregate sales price

Everything the company receives for the shares. Options are valued at their exercise price.

Restricted securities

Shares from a private deal that cannot be resold without registration or an exemption.

Summary plan description

The plan summary that ERISA requires, one of the items of Rule 701 disclosure above $10M.

RSU

A restricted stock unit: a promise to deliver shares later, usually after a vesting period.

Lock-up

A contract that blocks insiders from selling for a set time after an IPO.

Figures were last checked on October 21, 2026. The rules are United States federal rules. State securities laws and the company’s own plan documents can add requirements.