In the world of tech, it’s common—and frequently expected—that startups offer their employees’ company stock as part of their compensation package. If you’re a Millennial in tech, and your company offers an employee stock purchase plan, then take note because you’re sitting on an opportunity of wealth. Your employee stock purchase plan, or ESPP, might be one of the best benefits in your compensation package. Personally, it’s one of my favorites. If your employer offers an ESPP and you are not participating, you may be leaving thousands of dollars on the table. To maximize your ESPP’s value, it is critical to know some key dates and terms and understand the plan’s mechanics. Enter: an introduction to stock purchase plans.
ESPP 101: The Nuts and The Bolts
You know the saying, “there’s no such thing as a free lunch?” That doesn’t apply here because your ESPP is essentially free money. For this reason, most tech companies will use it to attract, reward, and incentivize their best talent. At it’s simplest, an employee stock purchase plan offers a way for tech employees to purchase company stock seamlessly and on favorable terms. Primarily, they allow participants regular, ongoing purchases of company stock through accumulated after-tax payroll deductions.
Moreover, participants can purchase company stock at a discount from the stock market price available to the general public. This discount is the free money I was referring to a moment ago. I’ve reviewed plenty of compensation packages for the Millennials in tech we serve as clients and have seen discounts ranging from 5% and 15%.
A Deal Too Good To Be True
What makes an employee stock purchase plan so appealing is the potential for both a discounted price and a lookback provision. As the name implies, the lookback feature allows employees to purchase shares based on the price at the beginning or end of the offering period, whenever share prices are lower.
For instance, let’s say the stock price is $100 per share at the start of the offering period. Your purchase price is $85 per share with the 15% discount.
- If the stock price goes to $200 per share, you’ll earn a hefty 135% ($200-$85/$85).
- Even if the stock price stays at $100, you’ll earn a 17.65% return from the discount ($100-$85/$85).
- Even if the stock price drops to $50 at the end of the offering period, your discount gives you a favorable purchase price of $42.50, as a result of the lookback feature.
As far as Uncle Sam is concerned, the money deducted from your paycheck will be taxed like the rest of your salary. However, for Millennials in tech who can delay instant gratification, you’ll be rewarded with preferential tax treatment from the IRS. Correspondingly, if you are willing to hold the shares for at least two years from date of grant and one year from the purchase date, any tax liability is deferred until the shares are sold. Like my mom used to tell me growing up, “patience is a virtue.”
A noteworthy reminder: if your company pays dividends to its shareholders, the deal gets even better. You’ll receive a check for the dividend amount each quarter for the stock you hold. If your company has a dividend reinvestment program, you have yet another opportunity to take advantage of dollar-cost averaging to buy even more shares of company stock.
Key Dates In Your ESPP
Now that we’ve touched on the mechanics, let’s get familiar with key dates, events, and terms associated with most ESPP’s. It’s helpful to think of these key dates as a timeline of the typical stock purchase plan’s life cycle.
Enrollment date: Known as the grant date is usually the first day of the offering period. The grant date is vital in ESPPs that are qualified plans, and it starts the clock for tax purposes.
Enrollment or offering period: During this period, payroll deductions are accumulated to purchase company stock. Most ESPP’s have offering periods that last anywhere from 6 months to 24 months.
Purchase period: Purchase period: Some tech companies use the terms “offering period” and “purchase period” interchangeably when the time frames are identical. Alternatively, when companies establish an offering period of longer than six months, there are usually interim purchase periods. Your company will purchase your shares at the end of the two six-month periods within the 12-month offering period. For example, a single offering period could be from January 1 to December 31. In this scenario, the first purchase period might start on January 1 and end on June 30. The second purchase period might start on July 1 and end on December 31.
Purchase date: Payroll deductions accumulated during the offering period will be used to purchase shares of company stock at the discount price on the purchase date. The purchase date is pre-determined and is usually the last business day of the offering or purchase period.
Reaping The Benefits
Investing in any individual stock is relatively risky: we all can acknowledge that. The most significant risk by far is not having a strategy or game plan to manage your shares as they begin to accumulate. Markets go up, and markets go down. It’s inevitable. In fact, this volatility is what causes an efficient market to demand higher returns for those who can keep faith. With risk comes reward, and hanging on for the long term is more often than not, rewarding. It’s unlikely to become wealthy overnight by participating in a stock purchase plan. Nevertheless, over time, the gains can be attractive. All the more reason for Millennials in tech to develop a holistic approach to stock compensation. If you’re not sure how or where to start, we’d be more than happy to help!