When your company launched its ESPP, it likely did so to recruit, retain and reward employees on a broad basis. Done right, 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. So, if your ESPP could use some Red Bull, let’s dive in and identify some of the ways you can retool your ESPP to include the features that participants value.
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 in employee engagement. Run a few if/then scenarios to help you determine if the benefits outweigh the costs.
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. And while this scenario may only seem advantageous for rising stock prices, 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.
2. Increase the discount
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. 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. 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, some shareholders don’t look favorably on reset provisions, so you will need to successfully argue that the benefit will be greater than the expense.
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. 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.
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.
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. 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. Check out our Top 5 Dos and Don’ts of Equity Plan Communication.
When you choose Shareworks by Morgan Stanley, 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. Drop us a line!