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Private Companies Need to Update Rule 701 Financial Statement Disclosures

image of server room Recently, the U.S. Securities and Exchange Commission adopted amendments to certain disclosure requirements in an effort to streamline rules and regulations and to remove requirements that are redundant, duplicative, overlapping, outdated or superseded. We previously summarized these amendments.

As part of these amendments, the SEC revised the financial statement requirements under Part F/S to Form 1-A to require an analysis of changes in stockholders’ equity for interim financial statements. Prior to these amendments, an analysis of changes in stockholders’ equity was not required for interim financial statements.

Because Rule 701 relies on the financial disclosure requirements of Form 1-A, private companies that are required pursuant to Rule 701 to provide financial statement disclosure in order to grant equity to service providers should ensure that they update their financial statement disclosures to provide an analysis of the changes in stockholders’ equity for interim periods presented in either a note to the financial statements or a separate statement.

Rule 701 Overview

U.S. federal securities laws require that securities be registered under the Securities Act of 1933, as amended, unless an exemption from registration is available. Rule 701 provides such an exemption for private companies making offers and sales of securities to certain employees and other service providers under written compensatory benefit plans (such as option and equity incentive plans). In many instances, Rule 701 is only available if the issuer provides its service providers with financial statements that are in compliance with the requirements of Form 1-A. Therefore, the recent changes to Form 1-A impact the scope of the financial disclosure requirements under Rule 701.  Please see Fenwick’s reference chart for a summary of the financial disclosure requirements.

New Financial Disclosure Requirements

Generally, Rule 701 requires that companies that are required to provide financial and other disclosure provide financial statements for the two most recently completed fiscal years or the period during which they have been in existence if it is shorter. These financial statements must include consolidated balance sheets and statements of income, cash flows and changes in stockholders’ equity. Interim financial statements also may be required to make sure that the date of the most recent financial statements is never more than 180 days before the securities are sold or issued.

Under the prior version of Form 1-A, changes in stockholders’ equity were only required to be reported for each of the two fiscal years preceding the date of the most recent balance sheet provided and were specifically not required to be provided for interim financial statements. However, after the amendments to Form 1-A, for any instance where a consolidated interim balance sheet is required under Form 1-A, an analysis of changes in stockholders’ equity reflected in the balance sheet must also be provided. The analysis must be provided in a note or separate statement and shall be presented in the form of a reconciliation of the beginning balance to the ending balance for each period for which a statement of comprehensive income is required to be filed with all significant reconciling items described by appropriate captions with contributions from and distributions to owners shown separately.

Impact of New Disclosure Requirements

As a result of these new disclosure requirements, private companies that are required to provide financial statement disclosures to certain equity holders pursuant to Rule 701 should ensure that they update their financial statement disclosures to include interim reports of changes to stockholders’ equity whenever interim financial statements are required.

For more information regarding new financial statement disclosures under Rule 701 (by way of revision to Form 1-A), please see footnote 445 on page 111 of the SEC’s adopting release and updated Form 1-A.

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