Not Your Father s ESPP. David Outlaw Equity Methods Phyllis Garland, CEP Computershare Marianne Friebel, CEP Dolby Laboratories

Transcription

1 Not Your Father s ESPP David Outlaw Equity Methods Phyllis Garland, CEP Computershare Marianne Friebel, CEP Dolby Laboratories

2 Agenda Most practitioners are naturally most familiar with their own company s plans. Our goal is to give you an overview of various ESPP designs and features available, along with some of the key, cross-functional ramifications of each. We will walk through different plan variations one by one We will begin with relatively common variations, then move into more novel features and circumstances We will discuss each from various angles, including administration, financial reporting, and communication -2-

3 Part I: (RELATIVELY) COMMON PLAN VARIATIONS -3-

4 Let s Start with a Poll -4-

5 Tax-Qualified vs. Nonqualified Qualifying for special tax treatment under IRC 423 Requires adherence to strict plan design constraints Employees can gain favorable tax treatment if holding periods are satisfied Nonqualified plans come with real benefits Corporate tax deductions regardless of employee sale timing Freedom from design constraints, opening up possibilities: Eligibility restrictions Greater discounts or other favorable features Uncapped value Employee communication Viewed as a take? Do employees take advantage of tax qualification anyway? -5-

6 Compensatory Plans under ASC 718 Plans that are not compensatory do not result in any compensation expense being recognized Must have 5% discount; no lookbacks or other option-like features Natural tradeoff between saving expense and giving employeefriendly benefit No need to be hypothetical: these accounting rules came into effect 10 years ago when ESPPs already were in place In practice, did companies adjust plans to become noncompensatory? -6-

7 Lookback Features Allows stock to be purchased at a discount from the lower of the stock price at the beginning or end of the purchase period Very employee-friendly, but communication can be challenging Accounting fair value must incorporate option-like features Illustration: Fair value of Type B plan, $100 grant price, 15% discount Volatility Term 20% 40% 60% 6 months $20.70 $26.31 $ year $23.12 $30.99 $ years $25.02 $34.58 $ years $26.67 $37.61 $

8 Time for Another Poll! -8-

9 Single vs. Multiple Purchase Periods Two approaches to structuring ongoing offerings Option 1: single purchase periods, back-to-back Often just six-month offerings to facilitate participation Option 2: multiple purchase periods per offering Involves different offerings overlapping with one another Potential pitfalls with systems and with employee communication Accounting expense and employee benefit: example Same assumptions as prior slide, plus $1,000 contribution per six months Stock price gain/loss Single PP, emp benefit Single PP, comp expense Multiple PP, emp benefit Multiple PP, comp expense + 15% per year $1,046 $1,238 $1,621 $1,523-5% per year $706 $1,238 $706 $1,523-9-

10 Resets and Rollovers Some plans allow for the lookback anchor price to reset when the price at purchase dips below the price at grant This feature can deliver much more value to the employee by ratcheting down their purchase price to the most favorable available This is a valuable feature, but naturally comes with administration and communication challenges Don t overlook details in the system: test environments can save headaches These features are accounted for as modifications when they occur (even if the feature is already part of the plan) Additional complexity if you have resets on top of resets in a sustained down market -10-

11 Part II NOVEL PLAN VARIATIONS -11-

12 Limited Eligibility IRC 423 requires plans to be nondiscriminatory If your plan is not intended to be tax-qualified, this requirement no longer exists You can determine ESPP eligibility as you do for other forms of equity compensation: rank, salary grade, tenure, etc. Since these plans are not tax-qualified, other design possibilities are also opened up Larger discounts, longer periods, etc. Special ESPP plans can be a vehicle for increasing executive share ownership -12-

13 Company Match in Shares With this design feature, the company would match (or match a percentage of) the shares purchased by the recipient Additional shares may or may not have further vesting requirements May be conditional on meeting holding period or occur upon purchase Good vehicle for increasing employee share ownership, but comes with administrative challenges Tracking dispositions of original and additional shares Additional shares from plan vs. buying on open market to reduce dilution As with any nonstandard design, accounting should not be the main deciding factor, but do bring your accountants in early There are multiple ways of looking at these plans, depending on facts and circumstances (e.g., treating matching shares as effective discount increase) -13-

14 Accruing Dividends / DERs Typically, ESPP participants receive dividends just like a common shareholder after a purchase occurs Some companies use purchased ESPP shares as a vehicle for treating dividends differently For example, paying dividend amounts into the next ESPP contribution rather than writing a check (in the absence of a traditional DRIP) Discounting the dividend reinvested Special dividend treatment requires special considerations Whether or not to pay interest Timing of purchases vis-à-vis record and payment dates Properly accounting for dividends, since standard models and tools assume they are foregone by participants -14-

15 Variable Discounts With nonqualified plans, terms need not be uniform For example, consider a plan where the purchase price is the lower of (i) 80% of FMV on offering date or (ii) 90% of FMV on purchase date Such a plan can align incentives: there is more to gain if the price increases, but less to gain if the price decreases Consider power of incentives in relation to purpose of your ESPP program -15-

16 Holding Period Requirements Holding stock for a period of time after purchase may already be attractive due to tax treatment, but companies may also impose mandatory holding periods Other variations on incentivizing employees to hold shares: Disallowing reenrollment for a time after sale Offering share match only if holding period is met Managing the employee side: Communication of additional complexities Impact on participation -16-

17 ESPPs in Corporate Transactions Handling ESPPs in M&A brings a unique set of challenges, and there is no single, one-size-fits-all way of treating the plan Assume the offering, cash it out, or integrate it into your plan? What if the target company has a plan, but the buyer does not? A major challenge stems from tracking dispositions for shares purchased pre-merger Complications from limited information provided by target, usage of different brokers, etc. Spin-offs present another layer of decisions and potential issues For example, tracking dispositions for shares purchased pre-spin and split into two different equities -17-

18 CLOSING THOUGHTS -18-

19 Questions? -19-

20 Speaker Information David Outlaw Equity Methods Phyllis Garland Computershare Marianne Friebel Dolby Laboratories