These days, lots of people are talking about employee ownership, employee share plans, and what those look like during a time of economic uncertainty. You might be seeing a lot more vocabulary and jargon thrown around in everyday conversation, including terms that you might not have heard before. One of those is ESPP, or employee stock purchase plan.
Here, we want to help you understand what an ESPP is, and how it can help both employers and employees. If you’re an employer, even if you know exactly what an ESPP is, it can sometimes be hard to communicate this message to others. And if you’re an employee, this is a good chance to understand why you might start hearing this term even more often.
What is an Employee Stock Purchase Plan (ESPP)?
An employee stock purchase plan (ESPP) is an employee ownership plan that allows participants to purchase stock in their companies at a discount. The way they do this is by making monthly contributions directly from their paychecks, building up a savings pot until the purchase date.
The participants, since they are buying stock for a discount and then selling for the normal price, can buy low and sell high. Some ESPPs have second insurance against risk. They can offer what is known as a ‘lookback clause’ in addition to the discount.
Here’s an example of a lookback clause in action:
The ESPP’s purchase date is December 31st. On that date, the share price is €10. The ESPP’s rules give participants a 15% discount, as well as a six-month lookback clause. During the offering period, the price was €5. So, the participant purchases stock at a 15% discount off the price of €5, rather than €10. And if the price during the offering period had been higher, for example, €15, then the participants would purchase their stock at a 15% discount off the price of €10.
Different ESPPs can offer different benefits, but most include a discount as well as a lookback clause.
Qualified vs. Non-qualified ESPPs
There are two types of ESPP – Qualified and Non-qualified. The term ‘qualified’ refers to a tax-advantageous status.
Qualified ESPPs are tax-qualified stock purchase plans, which offer several advantages to participants. The main one is that employees aren’t taxed on any discount they receive on the stock purchases.
Characteristics of a tax-qualified ESPP include
- Shareholder approval; In order to institute an ESPP, the company must first get formal approval from shareholders.
- No taxes on stock price discount; Employees do not pay taxes on the discount difference, however, they do pay capital gains on any gain in the value of their ESPP stock between buying and selling.
- Limited offering period; The purchase date must be within 3 years of the offering date.
Non-qualified ESPPs have fewer restrictions, however, they don’t have the same benefits as tax-qualified ESPPs.
Some of the differing tax consequences for non-qualified ESPPs include:
- Non-qualified ESPPs are liable for income tax on the discount they receive when they purchase shares.
- As with a qualified ESPP, employees must pay capital gains tax on any increase in the value of their stock between purchase and selling.
What are the benefits of an ESPP?
They Can Generate a Substantial Return For Employees
ESPPs offer employees the potential of a favorable return on investment as well as a way to gain ownership in their company. They also offer employees an easy and cost-efficient reward for pursuing a disciplined savings plan and allows them to build long term financial wealth.
It Fosters A Long Term View
Employees who hold company stock will both think and act in the long term interest of the company. By having skin in the game, an employee is aligned with the character and vision of your company.
It Helps Your Employee Retention Rate
ESPP programs typically run over a number of years, and the total amount of stock employees accumulates over the lifetime of the plan. Seeing is believing, and an employee who sees the financial benefit of their investment after the first six months is more likely to commit and remain invested in the company in the long run.
Tax and regulatory compliance
The design and deployment of ESPPs must meet the letter of the law. There are many considerations to be taken into account including variations in tax rates between states, employee mobility and transfers, an international workforce, tax liability etc – which is why many companies choose to work with external advisory partners to ensure they remain fully compliant with a tax and regulatory perspective.
Administering an ESPP
If you already have an employee stock plan, you need to ensure that your staff are engaging with it and that everything from participant enrollment to trading is taken care of and above board. If ESPPs are new to your company and something that you’re considering, speak to a company like Global Shares can take away the headache of managing it thanks to our award-winning software platform and a team of 300 equity professionals. We’re trusted by hundreds of companies across a multitude of industries in more than 100 countries across the world.
Moving forward, together
When you have shares in your employing company (which you do with an ESPP), it means that your hard work for the company directly translates into a higher reward for you. The better a company does, the higher its stock price is. The higher their share price is, the more profit you make when you sell your shares. Which is good financially, but it also fosters a community spirit. Everyone in the company, no matter which department they’re in, have their interests aligned – with the company, and with each other. This in turn makes teamwork even easier.
Not only that but knowing that every success you have in work directly impacts you and your colleagues adds purpose to even small victories. Studies show that employees participating in employee ownership plans have higher job satisfaction, and it’s easy to see why.
Request a free demo
If you’ve been curious about all the benefits of ESPPs or employee ownership – or you want to understand how they can help your company specifically, contact us today for a free demo. Our experts will walk you through the entire process, and see which plan is best for you.