Get the lowdown on quick-sales, look-backs and resets

10 Ways to Revive a Lagging ESPP Strategies for U.S. plans

So, your ESPP is in a slump. When your company set up the plan, it likely did so to recruit, retain and reward employees, which are all great objectives. Broad-based ESPPs can also encourage ownership behavior and increase productivity, so it can be frustrating when you don’t see the participation rates your company needs to realize a good return on its investment. The fact is that the most elegant plan can’t help you achieve your goals if employees don’t buy in.

According to the National Center for Employee Ownership, participation in U.S. ESPPs is on the rise, and a down market is arguably the best time to participate.1 If, despite the uptake we’re seeing in participation, you’re still experiencing widespread disengagement with your ESPP, plan design may be the culprit. So, if your ESPP could use some Red Bull, now is a perfect time to redesign some of its features to encourage participation, since now is a very beneficial time for employees to buy in. In this white paper, we talk with Bruce Brumberg, Editor-in-Chief and Co-Founder of myStockOptions.com – a highly-respected, independent provider of web-based educational resources on ESPPs and other forms of equity compensation – to identify some of the ways you can retool your ESPP to include the features that participants value.

The time is right to give your ESPP a lift

1. Lengthen the offering period In the case of 423 plans, longer offering periods are more beneficial for employees because they increase participants’ odds of getting a really beneficial look-back. Six months is the norm, but you could look at increasing it to up to 24 months. “A 24-month offering period with purchase periods every six months lets employees get a bigger discount when the stock price keeps rising throughout the offering, as the look-back uses the lower starting price,” says Brumberg. And while this scenario may only seem advantageous for rising stock prices, Brumberg points out that “a related feature can be implemented for the possibility of a falling stock price that would automatically remove employees from that offering and start a new offering with the lower look-back price.” This is known as a reset provision (see point 5, “Add a reset feature”). And while a longer offering period will usually increase the expense for the plan, that cost could be offset by increased participation and ROI.

The cost-benefit chat

There’s no getting around it. Adding popular features will adversely affect your accounting expense for the plan. But to use an apropos analogy, your ESPP is an investment, and you have the power to make it a good one. If spending a little more on your share purchase plan could net you 80% participation, consider the dividends it will pay. Run a few if/and scenarios to help you determine if the benefits outweigh the costs.

There is also a strong argument that, in this market, companies are wise to spend on their ESPPs rather than on options plans. It’s very easy in a down market for options to go under water, and you will take a hard cost whether or not anyone is exercising. In the case of 423s, there is a benefit to the employee even if the stock price decreases. Yes, there is an accounting expense with ESPPs, but you’re guaranteed to see a return.

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20

40

60

80

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Employee ownership: 81%

Corporate identify/ownership culture: 52%

Align with shareholder interests: 51%

ESPP priorities

Source: 2011 Domestic Stock Plan Administration Survey. NASPP. Sept 2011.

1 http://www.nceo.org/main/column.php/id/387

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2. Increase the discount “Companies offering a 10% or 15% discount off the stock price tend to see high participation rates,” says Brumberg. “Going with the 5% discount for the accounting safe harbor may greatly reduce participation and draw criticism.” If your 423 plan doesn’t already offer the maximum discount of 15%, consider doing so. This is undoubtedly the most powerful benefit you can offer your participants and is the most readily understandable and appreciated.

3. Add a company match Most companies with 423 plans don’t offer an employer match because participants are already enjoying a discount, but some do. This might be a feature you’d want to add if you don’t offer the maximum discount or if you’re in a particularly tough job market. If you have a non-qualified plan, a match can be a powerful incentive to participate. It’s the closest thing there is to a free lunch. Brumberg points out that this is a top feature for non-qualified ESPPs.

4. Increase the contribution maximum Contribution maximums usually range from 1% to 10%. If your company is at the lower end of the scale, consider giving this a nudge. But remember that an employee may not purchase more than $25,000 worth of stock (determined based on the fair market value on the first day of the offering period) for each calendar year in which the offering period is in effect. In addition to the $25,000 IRS cap, there will likely be an individual cap per offering in the plan. Even if they can contribute at a higher percentage, the participant is capped at whichever of these limits is lower.

5. Add a reset feature A reset provision can be especially useful for plans that have longer offering periods – 12 to 24 months – with purchases every six months. Under a reset provision, if the price between the offering date and purchase date drops, the start date of the look-back is reset to the current date. This gives employees the lowest possible purchase price. Reset features will create an added expense, and the cost can be substantial. In our experience, shareholders don’t look favorably on reset provisions, so you will need to successfully argue that the benefit will be greater than the expense.

Companies offering a 10% or 15% discount off the stock price tend to see high participation rates. Going with the 5% discount for the accounting safe harbor may greatly reduce participation and draw criticism.

Bruce BrumbergEditor-in-Chief, Co-FoundermyStockOptions.com

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6. Shorten your purchase period Employees can be wary of participating in plans that have purchase periods longer than six months. Shorter, more frequent purchases are better for participants because their funds are not tied up for too long. The sweet spot is generally acknowledged to be three to six months. According to the NASPP’s 2011 Domestic Stock Plan Administration Survey, 21% of companies with 423 plans have three-month purchase periods. That number is up from 13% in 2007. Note that going with shorter, more frequent purchases can increase the administrative work, so the cost of that needs to be factored into your decision.

7. Enable decreases during a purchase period If you’d prefer not to shorten your purchase period, another method of realizing a similar benefit is to give participants the ability to modify their allocations within a purchase period. Some employees may be concerned about needing access to cash, so offering the ability to decrease the percentage of their payroll deductions can be an important feature. This includes the ability to drop to 0% so the participant can still stay in the plan and purchase at the end of the period without withdrawing completely. You don’t want to offer an increase, because that is going to affect your accounting.

8. Lift your holding requirement “While there can be tax advantages to holding for at least one year from purchase and two years from the offering date, recognize that employees have tied up their cash for the purchase period and may want the proceeds immediately or soon after purchase,” says Brumberg.

9. Add a quick-sale program Critics of quick-sale programs argue that they discourage employee ownership culture, which is typically seen as one of the benefits of ESPPs in general. But at least some of your employees may prefer to either access cash or diversify their portfolios, which is a sound investment principle. If the majority of your employees are in their acquisition years – buying big-ticket items like homes, appliances and cars, they may want to sell some or all of their shares as soon as they get them. With a quick-sale, as soon as the purchase allocation is calculated, the company’s broker partner sells the shares for the participating employees in a single block when the market opens the day after the purchase date. This locks in the actual gain received as close to the purchase date as possible, allows the broker to liquidate a potentially large number of shares with minimal market impact, and simplifies the trading process for the participants. In addition, the fees for a quick-sale are usually lower per participant (since they are getting the benefit of the large block-trade commission). The employer might even pay the fees for participants as a further incentive.

Disposition of acquired shares

This chart shows the average length of time particpants held shares in 423 plans.

Held 2 years or more: 32%

Held 1-2 years: 27%

Held 6 months to 1 year: 16%

Held less than 6 months: 13%

Sold almost immediately: 13%

Source: 2011 Domestic Stock Plan Administration Survey. NASPP. Sept 2011.

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myStockOptions.com boasts exclusive articles, 750+ FAQs, podcasts, the Tax Center, the Learning Center with courses for CEP and CPE credit, the Global Tax Guide, an extensive glossary and interactive patented tools. It’s the premier online source for educational content and tools on stock options, restricted stock, restricted stock units, performance shares, stock appreciation rights and employee stock purchase plans. Resources are written and managed by leading experts in equity compensation and are produced by a company with a long history of successful publications explaining complex legal and financial subjects in plain English.

For more information about ESPPs, see the many resources at myStockOptions.com, including articles and FAQs, a podcast, a quiz, ESPP coverage in the Global Tax Guide, and the ESPP course and exam for CEP and CFP continuing education credits in the Learning Center.

Final thoughtsMany companies seek the assistance of a compensation consultant to design their stock option plans, but their ESPPs are often developed by lawyers. When you choose Solium, you benefit from deep industry expertise. We can help you assess your current program and provide recommendations to assist you in creating an ESPP that fits your company. We’ll consider your specific goals and objectives, industry practices, employee demographics and administrative concerns.

To learn more, contact Solium at solutions@solium.com.

A quick-sale program can be a little challenging for stock plan administrators because it usually requires a manual process. Note that good employee education is important because participants will need to understand how the program works and sign up ahead of time.

10. Educate, educate, educate “Employees like accessible communications and education that fully describe the ESPP features,” says Brumberg. Remember that many people find investment intimidating, an issue that is compounded if a large segment of your employees are not financially savvy. Plain language communications that clearly describe the benefit to employees will go a long way toward encouraging participation.

Coming soon! Watch for a new Solium white paper that focuses exclusively on communicating equity compensation to employees.

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About Solium

Solium is a leading global provider of web-based stock plan administration technology and services. Shareworks®, our industry-leading software, provides unrivaled, comprehensive regulatory and financial reporting capabilities, helping companies automate and manage their stock option and purchase plans.

Since our inception in 1999, we have been known as industry pioneers, always striving to change the status quo and challenge conventional methods. We take great pride in being leaders of change and delivering the most innovative stock plan administration experience possible for finance and HR professionals, plan administrators and participants. Solium has offices in Canada, the United States and the UK.

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