William Wong Feb 2018
stocks
How to Argue for and Against Them
Offer packages are becoming increasingly complex in today's War for Talent. Many corporations are utilizing equity based compensation as a carrot to woo, motivate and retain their employees. This article will arm you with the knowledge of these equity incentive instruments so you may guide your candidate into making the correct choice - your offer.
They come in the form of Stock Options (ISOs and NSOs), Restricted Stocks, Restricted Stock Units (RSU), Phantom Stock, Stock Appreciation Rights (SARs) and Employee Stock Purchase Plans (ESPP). We will cover three of the most popular choices you'll encounter in comp packages and how they compare to one another.
EMPLOYEE STOCK PURCHASE PLAN (ESPP)
Understanding and maximizing a great employer benefit you may be missing out on
Introduction
ESPP is only available to employees of publicly traded companies. This plan allows you to purchase shares of your employer's stock at a discounted rate via payroll deductions. You basically deduct a portion of your after-tax payroll for this plan and it accumulates until the Purchase Date, at which time the company will take the accumulated funds to purchase the stocks (again, at a discounted rate). Has 4 parts:
01/
Enrollment Period
When you decide what percentage of your income you'd like to deduct each payroll cycle. Companies often have restrictions on how much you can contribute, say up to 15% of your income. The IRS also caps this contribution to max $25k/year.
Offering Period
02/
The duration of the ESPP - often times its 12 or 18 months. Each offering period is often broken up by several purchase periods.
03/
Discount Rate
The reduced rate you're able to buy your stocks. The discounted rate differs from company to company but it's normally around 15% (or at 85% of the stock price). ESPPs may also have a "look back" clause that lets you to purchase the stock at either the first day of the offering period or the last day of each purchase period (which ever is lower).
04/
Purchase Period
Time when you are able to take your accumulated funds and buy the stocks.
Scenario
Your company allows a 15% discounted rate.
Their ESPP has a 18 month offering period (1/1/20 - 06/30/21),
It is broken down into 3 six month purchase periods
You make $100k and decide to contribute 15% of income ($15k)
This means each purchase period you have $7,500 to buy stocks.
The price of the stock is
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$50/share at the beginning of the offering period.
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$55/share at the first purchase period
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$45/share at the second purchase period
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$60/share at the third purchase period
01/01/20 06/30/20 07/01/20 12/31/20 01/01/21 06/30/21
Purchase Period
Purchase Period
Purchase Period
Offering Period
1st Purchase Period
Since the price of the stock at the beginning of the offering period (1/1/20 @ $50) is lower than the price of the stock at the end of the first purchase period (6/30/20 @ $55), you will be able to purchase your stocks at $42.50/share (85% of $50).
You are contributing $7,500 this purchase period, which allows you to buy 176.47 shares of stock (7500/42.50).
If you were to sell the stocks instantly at $55/share, it will give you $9,705.85. This gives you a profit of $2,205.85
2nd Purchase Period
Since the price of the stock at the end of the 2nd purchase period (12/31/20 @ $45) is lower than the price of the stock at the beginning of the offering period (1/1/20 @ $50), you will be able to purchase your stocks at $38.25 (85% of $45).
You are contributing $7,500 this purchase period, which allows you to buy 196.08 shares of stock (7500/38.25).
If you were to sell the stocks instantly at $45/share, it will give you $8,823.60. The stock fell but you still made $1,323.60
3rd Purchase Period
The price was $50 at initial offering, rose to $55 during the 1st PP but dropped to $45 at 2nd.
As a counter to any declines - most plans will reset the offering period to the last day of the previous purchase period if the price of the stock declines below the initial offering.
In this scenario, the initial offering will reset to $45. When the price of the stock rose to $60 in the 3rd purchase period, you can buy the stock at $38.25 (85% of $45), and sell at $60 - giving you a whopping profit of $4,264.71.
Additional Notes
Now that you know how an ESPP works, it's important to examine two other items. First, we go over Uncle Sam's cut of your profit. The second portion touches on the main highlight of an ESPP. This is a huge selling point that most people don't even realize.
Tax Implications
The IRS will look at how long you've held your stock to decide whether to tax it as ordinary income or capital gain (loss). The two methods are called Qualifying Dispositions and Disqualifying dispositions. Details of this can be seen here, but if you follow the widely accepted recommendation to sell your stocks immediately upon purchase, then prepare to have your gains be taxed as ordinary income.
Amazing Investment Vehicle
ESPP is a wonderful investment option because there's very little downsides. Most financial advisers do suggest you only invest as much as you can afford and to sell as soon as you purchase your stock.
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Minimum ROI: if your ESPP has a look back option, then it doesn't matter if the stock drops below the offer price because you can just use the lower of the two prices. Do the calculation and you'll see that even a catastrophic loss (aside from it being de-listed) will result in a 17.65% return. That there is the floor on your investment, you will always get a min of 17.65% return. Hard to beat this type of investment.
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Better than expected ROIs: In the above scenario, we see that even on a bad day, we're still making a 17.65% return. However, since you were tucking money away over the span of 6 months (with the first contribution being tied up for a full 6 months but the last was only tied up for a few days), on average your funds were only tied up for 3 months. You ready for this? Earning a 17.65% return over 3 months is equivalent to a 91.6% a year return [ (1 + 17.65%) ^ 4 – 1 or full details here ]
1) Stock Trajectory: Is their stocks trending up or down? If it is down then they will most likely only realize the floor gains (18% if they allow a 15% discount. The return is less for a smaller discount). Since the IRS will only allow a max of $25k contribution per year, their actual gain will be $4,500 ($25k * 18%). Is your RSU or higher salary package better than $4,500? If so, you have an easy sell. Looking at the trajectory of the stock also provides other thrashing points.
2) Estimate Actual Gains: What if their stocks are trending up? Here we examine the gains that your candidate could realize out of the ESPP. You need to figure out the breakdown of their ESPP and look at the time between each purchase periods. Your candidate probably don't know this because most candidates don't go into this granular detail, in this case just use a standardize 6 months. Now look at the performance of their stock for the last 12 months, and check out their stock price 1 year ago (use this as their initial offering period), 6 months ago (1st purchase period), and current price (2nd purchase period). Calculate their earnings as if they were participating and compare those earnings with your package. Does it offer favorable talking points? If so, highlight them.
Remember to sell the intangibles of your offer against the others. But if we are purely arguing on the principals of which compensation package is better, here are some tactics you can use:
[ ! ] How to Argue Against Them