It is quite common for people affiliated with a startup to receive Rule 144 stock in lieu of cash or readily tradable stock. This type of stock is usually issued by a company that is either about to go public or has recently gone public.
Rule 144 stock is often used as a form of reimbursement for services related to an initial public offering (IPO). Many startups don’t have the cash to pay for professional services and have to resort to paying for legal, consulting, or marketing services in securities that are not yet tradable. Additionally, some officers, directors, or even regular employees of a startup are quite commonly paid in stock for their services.
However, the stock carries with it a restriction as to salability. The problem with this type of payment is that you might have a long wait before you can sell the stock and garner your hard-earned cash.
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The Securities and Exchange Commission (SEC) commonly refers to this type of stock as a “restricted security” or “control security.” Since the SEC has specific rules as to when and how these shares can be traded, this means that although you are a shareholder of a company whose stock is publicly traded, you might not be able to sell that stock in the open market.
Although, with the technology boom, there have been many instances where people became millionaires when they eventually sold their 144 stock. There are also many instances where the company doesn’t get off the ground and, when you are finally able to sell your stock, it may be worthless.
Therefore, I have a word of caution to anyone receiving this type of security as a form of compensation. Though you may have something valuable, it may not be very liquid until the restrictions of the 144 Rule are lifted.
When Can 144 Stock Be Sold?
So, when can you sell 144 stock? This is a rather involved question, but I’ll make the response as simple as possible. The following are key elements that can potentially restrict your sale of 144 stock.
As a general rule, if you acquire securities in the marketplace, they are not restricted, and you can sell them whenever you like. However, if you acquire securities that are issued directly by a corporation and they have not been registered with the SEC, you will very likely come under the 144 holding period. To further confuse this issue, if the SEC regards you as an “affiliate” of the issuing company, you may not be able to sell your securities because of the 144 Rule.
Sound confusing? It is somewhat. But in most instances, a one-year holding period is the time frame you will be concerned with. Assuming that you performed all necessary services for which you were paid with these securities, this holding period begins when the securities were acquired.
If you are later granted additional securities for services rendered, they will carry with them their own holding period and will not effect the acquisition date of your previously granted securities.
Adequate Current Information
This particular requirement is pretty much out of your control. It is met when the issuing company has filed all required reports with the SEC under the Securities Exchange Act of 1934.
You can inquire of the company’s market maker or corporate attorney to determine whether this requirement has been met. Also, you or your attorney can contact the SEC directly to be assured that the company’s filings are current.
Assuming that your one-year holding period has passed, there is a limit on the number of shares that you may sell. In this case, rather than try to explain this rule, I refer you to corporate counsel or your own counsel — assuming, of course, that he or she is conversant with securities laws.
The major import of this rule is that it limits your sale to a percentage of the outstanding shares of the company or an amount based upon average previous trading volume. A bit confusing — that’s why I recommend that you consult an experienced attorney.
There are other factors to be considered such as filing a notice with the SEC concerning your sale. In addition, there are certain other restrictions that may apply to your sale.
Here again, I must say that you have to consult with your attorney to be sure that you have met all of the requirements under Rule 144.
Is It Worth the Effort?
So, is 144 stock worth the effort? My answer is maybe. There is nothing inherently wrong with receiving 144 stock for services rendered. Many people have become quite wealthy upon selling their 144 stock once the holding period is past.
There are many cases of startups being strapped for cash and having to give up equity to obtain services from professionals and employees. One can’t necessarily blame the startup for being in that position. So many startups have succeeded and prospered even though their success seemed doubtful at the beginning.
On a number of occasions, I have taken 144 stock in lieu of compensation for services. In most of the cases, I made out quite well. In a few cases, the stock never became valuable.
It all comes down to a judgment call as to whether you should take this type of stock. If you really believe in the prospects of the company, by all means take the stock.
If you are unsure, my suggestion would be to demand cash, assuming you can get it. Another alternative is to ask for cash plus stock. This way, you’ve got your bets covered.
Theodore F. di Stefano is a founder and managing partner at Capital Source Partners, which provides a wide range of investment banking services to the small and medium-sized business. He is also a frequent speaker to business groups on financial and corporate governance matters. He can be contacted at [email protected].