ESPP How-To #2: Know the Discount

Stock Option Counsel, P.C. - Legal Services for Individuals.  Attorney Mary Russell counsels individuals on equity grants, executive compensation design, employment agreements and acquisition terms. She also counsels founders on their personal interests  at incorporation, financings and exit events. Please see this FAQ about her services or contact her at (650) 326-3412 or by email.

The discount is the “win” of an ESPP because it allows you to buy stock for less than the market price. Most ESPPs use a discount percentage of 5-15% off of the market price.

Big Win = Look Back Discount

The best ESPPs “look back” in time to calculate an even better discount for employees.

On the date of each purchase, an ESPP with a Look Back will calculate the purchase price by applying the discount percentage to the lesser of (1) the market price on a date months or even years before the Purchase Date (for Cisco, the Offering Date) or (2) the market price on the Purchase Date.

A Look Back is valuable if the market price of the company’s stock is rising during an Offering Period, as purchase prices during that Offering Period would be calculated using the low market price of the first day of the Offering Period (Offering Date).  For example, if the market price goes up from $10 to $20 over a tw0-year Offering Period and a company uses a 15% discount percentage, the purchase price on the last day of the Offering Period would be $8.50. That would be a discount of $11.50 off of the market price on that day.

Cisco’s Purchase Price Calculation

Cisco’s ESPP has a 15% discount and a two-year Look Back. Therefore, joining a Cisco Offering Period locks in the right to buy stock with a maximum price of 85% of the market price on the first day of that Offering Period. Even if the market price of the stock rises dramatically over the two years of the Offering Period, the employee’s maximum purchase price on each Purchase Date in that Offering Period is 85% of market price on the first day of that Offering Period.

Cisco’s Purchase Price on any Purchase Date is the LOWEST OF:

1. 85% of the market value of the stock on the Offering Date OR

2. 85% of the market value of the stock on the Purchase Date.

Transient

Cisco Up Market Example: If the market price on the Offering Date is $15 and the market price on the Purchase Date is $25, the Purchase Price for that Purchase Date would be $12.75 – 85% of $15. That would be a discount of 49% off of the market price on the Purchase Date. If the employee sold the stock immediately after the Purchase Date, he or she would have a gain (winnings) of $12.25 per share.

Cisco Down Market Example: If the market price on the Offering Date is $15 and the price has dropped to $10 on the Purchase Date, the Purchase Price for that Purchase Date would be $8.50 – 85% of $10. That would be a discount of 15% off of the market price on the Purchase Date. If the employee sold the stock immediately after the Purchase Date, he or she would have a gain (winnings) of $1.50 per share.

Cisco Reset Feature

Since the goal of an Offering Period game is to lock in the lowest possible Purchase Price, the Cisco ESPP automatically cancels any Offering Period after any Purchase Date on which the market price is less than the market price on the Offering Date. New Offering Periods start every six months, so participants are automatically enrolled in a new Offering Period starting after that Purchase Date. This lets employees take advantage of the lower maximum Purchase Price of the new Offering Period as the market price on the new Offering Date will be less than the market price on the cancelled Offering Period’s Offering Date. 

 

More in the ESPP How-To Series:

Intro To ESPPs

Timeline the ESPP

Know the Discount

Calendar Your Bets & Play to Win

Tax Basics

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Stock Option Counsel, P.C. - Legal Services for Individuals.  Attorney Mary Russell counsels individuals on equity grants, executive compensation design, employment agreements and acquisition terms. She also counsels founders on their personal interests  at incorporation, financings and exit events. Please see this FAQ about her services or contact her at (650) 326-3412 or by email.

 

ESPP How-To #1: Timeline the ESPP

Stock Option Counsel, P.C. - Legal Services for Individuals.  Attorney Mary Russell counsels individuals on equity grants, executive compensation design, employment agreements and acquisition terms. She also counsels founders on their personal interests  at incorporation, financings and exit events. Please see this FAQ about her services or contact her at (650) 326-3412 or by email.

Playing and winning the ESPP game is not as simple as writing a check to the company and receiving discounted stock. To maximize ESPP benefits, the first step is to understand the timeline of important events in your ESPP game.

In most ESPPs, the timeline flows like this: (1) employee enrolls to participate in an Offering Period and agrees to have the company deduct a percentage of his or her income to hold for later purchase of the company’s stock; (2) payroll deductions continue throughout the Offering Period; (3) the company holds onto the employee’s payroll deduction funds until special Purchase Dates; and (4) on each Purchase Date, the employee’s accumulated funds are automatically used to purchase discounted company stock for the employee.

Cisco ESPP Timeline

Cisco starts two games (Offering Periods) per year. Each Offering Period lasts for two years and has four six-month rounds (Purchase Periods) within it.

Transient

If a Cisco employee signs up for an Offering Period during Open Enrollment, he or she authorizes the company to take a percentage of his or her income at every pay period during the Offering Period (Contributions).

Cisco holds the employee’s Contributions on his or her behalf to purchase stock at the end of each Purchase Period within the Offering Period. The dates on which the purchases are made are called Purchase Dates.

Transient

Contributions accumulate during each Purchase Period. On the last day of each Purchase Period (the Purchase Dates), the employee’s Contributions are used to purchase Cisco stock at a discount. The company creates a special brokerage account for each employee and deposits the stock into that account after each Purchase Date.

More in the ESPP How-To Series:

Intro To ESPPs

Know the Discount

Calendar Your Bets & Play to Win

Tax Basics

Stock Option Counsel, P.C. - Legal Services for Individuals.  Attorney Mary Russell counsels individuals on equity grants, executive compensation design, employment agreements and acquisition terms. She also counsels founders on their personal interests  at incorporation, financings and exit events. Please see this FAQ about her services or contact her at (650) 326-3412 or by email.

ESPP How-To: Introduction to the ESPP Game

Stock Option Counsel, P.C. - Legal Services for Individuals.  Attorney Mary Russell counsels individuals on equity grants, executive compensation design, employment agreements and acquisition terms. She also counsels founders on their personal interests  at incorporation, financings and exit events. Please see this FAQ about her services or contact her at (650) 326-3412 or by email.

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Mary Russell counsels individual employees and founders to negotiate, maximize and monetize their stock options and other startup stock. She is an attorney and the founder of Stock Option Counsel.

Big companies offer an ESPP as an employee benefit, but reading the rules and learning to play can make an ESPP more of a burden than a benefit. This blog series outlines how to maximize your ESPP benefits by learning to play to win.

The next posts cover these how-to steps:

1.  Timeline the ESPP

2. Know the Discount

3. Calendar Your Bets & Play to Win

4. Tax Basics

The examples in this series are all based on Cisco’s ESPP. It’s a good example because the Cisco ESPP is very generous in its discount calculation and also allows employees to control their risk by making changes to their contributions or withdrawing from the program. This is great for Cisco employees and also great for learning how to work an ESPP to work for you.

Win/Lose Basics

We’ll keep it simple in this series and focus on the ESPP as a game rather than as part of an investment portfolio. Once you know your rights and choices in this “game,” you’ll be able to consider it as part of your portfolio with more sophisticated investment focus. But for this series:

Winning = Buy stock and sell it for more than you paid for it. An ESPP makes this win more likely than on a regular stock market bet because the company sells company stock through an ESPP at a discount from the market price.

If you use your ESPP to buy stock at a discount and sell it immediately at the market price, you’ve almost surely made a winning bet. For example, Cisco allows immediate sales of ESPP stock and their discount is (at least) 15% on the date of purchase. If the market price for Cisco stock is $20 on the date of purchase, the discounted price would be (at most) $17, and an immediate sale of the stock would be a win of (at least) $3 per share.  

Losing = Buy stock and sell it for less than you paid for it. This happens if you continue to hold the stock after you purchase it (rather than selling it immediately) and the market price has dropped below your purchase price when you finally sell it.

Read on for:

1.  Timeline the ESPP

2. Know the Discount

3. Calendar Your Bets & Play to Win

4. Tax Basics

Stock Option Counsel, P.C. - Legal Services for Individuals.  Attorney Mary Russell counsels individuals on equity grants, executive compensation design, employment agreements and acquisition terms. She also counsels founders on their personal interests  at incorporation, financings and exit events. Please see this FAQ about her services or contact her at (650) 326-3412 or by email.