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The Implications of SEC Rule 144 on Employee Stock Options

SEC Rule 144 governs the sale of restricted and control securities. If you work for a venture-backed startup company that has not yet gone public, you will be purchasing restricted stock when you exercise your stock options. If you are a founder, executive, or a board director, then your stock may be subject to additional restrictions as a control security. If you wish to sell your stock prior to the issuing company going public and the expiration of the restrictions, then you will need to comply with the exemptions provided by Rule 144. The most significant requirement is the one year holding period. There is also a shorter six month holding requirement under special circumstances but mostly for non-affiliates. After the holding period requirement is satisfied, holders of control securities who wish to sell more than 5000 shares or $50,000 in value within a 3-month period must also file Form 144 with the SEC to announce their intentions. Coincidentally, the one year holding requirement has the benefit of entitling the stockholder to receive long term capital gains treatment on possible gains from the stock.

The Rule 144 holding clock starts on the day your stock options are exercised. The main implication is that the holding requirement represents a period of illiquidity that can pose a significant financial burden to some employees. A low risk solution is to get funding from the Employee Stock Option Fund to cover the cost of exercising the options as well as any associated taxes. An ESO advance allows you to avoid tying up valuable personal capital as well as shielding you from the potential downside loss. Pursuing a transaction with the ESO Fund will not negatively impact the timing of your Rule 144 holding period requirements. If you already own restricted stock from a prior exercise but need liquidity during the Rule 144 holding period, then the ESO Fund can also provide financing under similar terms that will not impact your Rule 144 holding period.

Exercising stock options is risky for many employees. It can require a lot of capital to be tied up for long periods of time and be subject to the possibility of total loss. ESO transactions are attractive because they are tax-efficient and have no payments until a liquidity event is reached on the stock. And if the stock becomes worthless, ESO bears the risk of loss. For more information, please contact us at the ESO Fund.

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The ESO Venture Fund, LP does not provide legal or tax advice. The above transaction description is a general description only and all terms are subject to final documentation between ESO and loan recipient.