Rule 701 is a federal exemption under the Securities Act of 1933 that allows private companies (i.e. startups) to issue securities, such as stock options, to employees, consultants, and advisors. It provides a way for startups to attract valuable talent without having to register with the Securities and Exchange Commission (SEC) or go public. The rule sets certain limitations on the amount of securities that can be issued within a 12-month period, based on factors such as the offering price, outstanding shares, and company assets. If a company exceeds $10 million in securities issued, it must comply with additional disclosure requirements, including providing financial and investment risk information to recipients.

The benefits of Rule 701 include the ability for private companies to offer equity compensation to employees and service providers who may not qualify for other securities exemptions (such as qualifying as an accredited investor). It offers flexibility in designing compensation plans and supports the growth of startups with limited resources. However, there are limitations and risks involved. The rule imposes restrictions on the amount of securities that can be issued, and companies must comply with state securities laws. Securities issued under Rule 701 are considered "restricted" and cannot be freely traded until the company undergoes SEC registration, typically through an initial public offering (IPO) or other public listing. It is important for companies to monitor their compliance with Rule 701, as failure to do so may lead to penalties or issues with the SEC.

In summary, Rule 701 is a federal exemption that allows private companies to issue securities to employees and service providers. It enables startups to attract talent by offering equity compensation without going through the process of registering with the SEC. The rule sets limits on the amount of securities that can be issued within a 12-month period, and additional disclosures are required if the company exceeds $10 million in securities issued. While Rule 701 provides benefits in terms of flexibility and compensation options, companies need to be aware of the restrictions and compliance requirements associated with the rule.