Employee Stock Purchase Agreements
Three ways for an employee to buy stock in her company have similar names, but different intentions and outcomes. An Employee Stock Ownership Plan (ESOP) offers the employee a retirement plan, often set up as a 401k, that invests money in company stock. An Employee Stock Purchase Plan (ESPP) allows the employee an opportunity to buy stock at a discounted price through periodic payroll deductions. An Employee Stock Purchase Agreement (ESPA) offers the employee a contract agreement to buy a certain amount of stock at a given price on a given date.
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Elements of an ESPA
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The ESPA contract in simplest form states your name, your employer's name, the number of shares you will buy, the purchase price, the date of the agreement and the date of sale. According to the agreement, the purchase price per share may be less than the current market price, and may give you the right to buy the stock at some future time.
A Typical ESPA
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You become an employee in a relatively new business with publicly traded stock. Your skills would normally command a high salary. Instead, the business pays you a lower salary, and offers you an ESPA. The contract specifies that you can buy 25,000 shares of stock at a price per share that represents a $4 per share discount on the market price.
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Better Than A Salary
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In addition to giving you a $100,000 profit, the ESPA offers you a tax advantage. You do not have to report the $100,000 profit until you actually sell the stock. The alternative minimum tax does not apply to profits from ESPAs.
How You Pay For The Stock
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If you do not have sufficient liquid assets to pay cash for the stock in the ESPA, you may borrow funds from your bank, a credit union or even the company that sells you the stock. While the salary would have become a company expense, the loan becomes an asset. The different stockholder reporting treatment of money lent to finance your ESPA and money paid on a higher salary makes it easier for your employer to lend you the money than to pay you the same amount in salary.
ESPA With A Deferred Purchase Plan
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An alternative ESPA gives you the contractual right as of the date of the agreement to buy a certain amount of stock at a stipulated price, but at a later date. Often, the rise in the stock price between the agreement date and the date of actual purchase, together with the initial discount you received on the stock price in the ESPA, effectively pays for a considerable portion of the stock. If you have a contractual right to buy 10,000 shares at $10 per share, and by the purchase date the shares have risen from $14, the actual market value on the date of contract, to $22 on the date of purchase, financing the purchase becomes quite easy. A private bank or brokerage will agree to lend you the money in exchange for a security interest. You can hold the shares, or you can sell some of the shares, in this case 4,546 shares, to pay off the loan. You will retain 5,454 shares with a current value of a little under $120,000.
The ESAP Motivates Your Best Performance
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For a key employee whose performance may substantially impact the company's results, the ESAP provides a powerful incentive. The value of the stock at the time of sale depends upon the company's good results.
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