There once was a dedicated professional who was tasked with creating a company-wide stock plan at her new company. Henrietta Rachel Goldilocks (let’s just call her “HR Goldilocks”) had years of Human Resources and Compensation experience, but little interaction with broad-based equity compensation. She searched the web and spoke to some experts on the topic. Each expert had a ton of information, but many tended to discuss general trends rather than HR Goldilocks’ very specific needs. You see, HR Goldilocks worked at a company that had been publicly traded for many years. They had tried stock options and restricted stock in the past, but currently only used these for management-level staff. There weren’t many internal notes on why the company had stopped granting lower-level grants and awards. When she brought the topic up finance simply said “too expensive”, the CEO said “didn’t work”, the head of engineering said “worthless” and several staff members simply looked confused when asked.
HR Goldilocks knew that her company’s stock price had a history of volatile ups and downs. She also knew they depended on a purchase cycle that lent itself to periods where bonuses were strong and others when they were nonexistent. As a company that built most of its own goods and supported their own customer service center, she knew her staff was both broad and deep. As she continued her search she finally found a blog article that had a story that covered the main equity compensation issues at a high-level. The story went something like this…
HR Goldilocks stumbled upon a house in the woods that was filled with compensation instruments. Cash hung from the ceiling. Bonuses wallpapered the walls. The floor was covered in check stubs and total reward statements. And, on the massive desk in the middle of the room, there were three equity compensation plans.
She first saw a stock option plan. HR Goldilocks read how the employees recevied no compensation until they chose to exercise. They paid what the stock would have cost at grant and the company expensed the amount that was determined using a mathematical model. The staff received any gain. She also read that if the stock price went down (as her company’s often did) these grants had little retention value. However, if the stock price soared, values also skyrocketed often to unsustainable levels. These grants generally carried vesting restrictions of four or five years, far longer than some of her employees planned in advance. HR Goldilocks looked at the risks and rewards and decided that stock options were too hot for her company.
The second plan described restricted stock units. HR Goldilocks liked that they had value from the date of award. She read on to find that employees often viewed these awards as “gifts” and devalued them accordingly. She also found out that they often resulted in such small award sizes for lower level staff that communications became difficult. “Imagine,” she thought, “trying to explain a 3-year vesting of 17 shares!”. HR Goldilocks decided that RSUs were to cold for her company.
The third plan was an IRC 423 ESPP. It stated the rules were designed to support plans for broad-based participation. HR Goldilocks read that these plans require the employee participants to purchase stock from the company. The caveat was that the employee could be offered a discount of up to 15%. Even better, this discount could apply to both the start of a grant period or the purchase date. This gave the employees some value at the start and, if the stock price rose, an even better value at the end. And, this plan virtually ensured some value even if the stock price fell. She read how requiring the employees to make payroll contributions during each grant period helped them have some “skin in the game” and stay engaged. She also liked that fact that she could structure the plan to limit the number of shares purchased by any one employee and that even the highest compensated employees were limited by the plan to $25,000 in value each year. All this and purchases could be scheduled frequently, usually in six-month intervals. This plan was flexible enough to meet her compensation needs while limiting expense to meet the needs of the company. HR Goldilocks decided an ESPP was JUST RIGHT.
HR Goldilocks worked with a consultant and her internal team to create an ESPP that was custom-fit to their needs and everyone worked happily ever after.