Rewarding advisors, consultants and (potentially) your community with equity.

A note about Rule 701 and the definition of “advisors and consultants”.

Hey founders et. al. In today’s episode we zoom out from last weeks topic to talk about how Rule 701 of the Securities Act enables companies to reward contributors via equity. We also provide ideas on how to utilize this rule to better leverage your communities, along with some resources to read further and take action.

Rule 701

The reason you can even offer advisors equity or options in the first place, without looping in the SEC and triggering heavy compliance obligations, is because of the exceptions provided by Rule 701 of the Securities Act. Rule 701 allows companies to issue equity incentive awards, including stock options and restricted stock units (RSUs), without registering the offering with the SEC. However, in order to qualify for an exemption under Rule 701, your offering must fall into certain categories. One of which is offerings for “consultants and advisors”. Note that “consultants” are included here, and both groups may be rewarded with equity so long as they are natural persons who provide “bona fide services” to the issuer.

No topic has caused more confusion under Rule 701 than the definition of “consultants and advisors.” After Rule 701 came into being, the definition was first expanded greatly by SECs interpretive guidance and then pared back a substantial degree. So where does it stand now? What does “bona-fide services” actually entail? It’s truly anyones best guess at this point (see page 8-9).

Pressure is mounting for the SEC to clarify the types of workers meant to be included and expand the definition for today’s economy that includes worker-types not around during the drafting of the rule (i.e. gig-workers and “creators”). With crowdfunding and crowdsourcing becoming more mainstream, and tokenized economies innovating how compensation can be structured, one can hope for clarity around this issue.

Since it’s a vague, moving target, it’s hard to know whether you will operating within the bounds of this exemption and honoring the spirit of the regulation. It might make sense to issue equity to advisors or consultants only when they’re providing a service to your company beyond simply using your services or participating on your platform (perhaps something unique that they can bring to the table in an advisory or consultancy capacity). For example, you could engage drivers on your rideshare platform to also provide detailed feedback on the UI or other experience related to the platform, or engage users of your marketplace to create content specifically to promote the platform or educate the public. In essence, hire your platform users as consultants and reward them by giving them an ownership stake in the platform. Seems fair, right?

Of course, always check with an attorney to get advice on your specific fact pattern. This isn’t an area you’d want to wing it.

Tools and Resources

We are always adding to this list. See the full list of resources for founders here.

• Reading. (1) The actual Rule 701 and the SEC FAQs for the rule (scrolling required); (2) A great primer by UpCounsel on Rule 701; (3) and some blog post from Fairmint and Startup Law Blog on the same subject.

• Doing. Fairmint.co is focused on transitioning the world toward stakeholder capitalism (giving your users and community a stake in your company/project) and giving founders the opportunity to turn their equity into their most powerful community engagement tool. Check them out here.

Have any resources you'd recommend to other founders? Please fill out this form.

As always, thanks for reading. Stay lawyerly.

Brian

** Remember, this is isn't legal advice, and this commentary is solely my own, not that of Scale, LLP :) **