Paying Employees and Consultants with Equity

Authored by Bryan Springmeyer Bryan Springmeyer is a California corporate attorney who represents startup companies. The information on this page should not be construed as legal advice.

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Usually, individual grants of stock or options are awarded to employees or consultants pursuant to an equity incentive plan that has been approved by the board of directors and shareholders of the corporation. The purpose of these plans is to establish board and shareholder approved rules of administration for compensatory stock awards, rather than needing board and shareholder action for each individual grant.  Additionally, the most widely used federal securities exemption for employee issued securities and its state counterparts are available only if the securities are issued pursuant to a plan. For startups, the plan can be more comprehensive and flexible, as the board of directors and stockholders are generally a small number of people. In publicly traded companies, on the other hand, it may be harder to get a plan approved that does not sufficiently restrict the plan administrator’s discretion. The company usually allocates a specified amount of stock for the plan, either upon formation of the company or during an equity financing. This allocated stock is commonly referred to as the “option pool” or “employee equity pool”.

If an approved plan is in place, individual grants may be given to employees or consultants pursuant to the provisions of the plan and the discretion of the plan administrator. Under securities laws, the issuance of equity to an employee or consultant in exchange for services rendered may constitute a "sale" of securities, making the company an issuer and the employee an investor. Rule 701 provides an exemption to the registration requirement by allowing securities issued pursuant to an acceptable “Compensatory Benefit Plan” to employees or certain contractors (described below) to be exempt from registration. Unlike other exemptions, such as Regulation D, Rule 701 does not require a notice of transaction filing. However, state securities laws may require such a notice with the state regulatory agency. Good faith reliance on Rule 701, if it is later determined that it does not actually apply, allows you to point to other exemptions, such as Regulation D or Regulation A.

Can You Pay Contractors with Equity from the Plan?

So long as the plan allows for it, federal securities laws allow consultants and advisors to be paid with equity. Rule 701 allows for people (not business entities) who provide bona fide services to the company, not in connection with the offer or sale of securities to raise capital, to be paid in equity under the exemption of Rule 701.

State securities laws will apply to these issuances, as well. In California, Corporations Code §25102(o) exempts any offer or sale of securities fitting the Rule 701 exemption and the applicable regulations. The notice of transaction filing fee for 25102(o) is larger than other exemptions, namely 25102(f), which can also be used if applicable.

Related Pages:

Taxation of Employee and Consultant Equity Compensation