A Complete guide on Employee Stock Purchase Plan (ESPP)

Written By:
Team Qapita
September 11, 2023

What is Employee Stock Purchase Plan (ESPP)?

An ESPP, or employee stock purchase plan, is a program initiated by a company to enable its employees to buy its stock at a lower cost. This reduced price is often around 5-15% less than the stock's market value when purchased.

ESPPs function by permitting employees to set aside a specific portion of their earnings during each pay cycle, which is subsequently used to invest in the employer's stock. As the designated period concludes, the company buys shares on behalf of the employees at the discounted rate. In simpler words, instead of buying their company's stock outright, employees who take part in the program contribute to their plan via automated deductions from their paychecks.

How does Employee Stock Purchase Plan (ESPP) work?

The Employee Stock Purchase Plan operates selectively; not every employee is eligible. Employers evaluate a group of employees, picking those who have shown strong and consistent performance, with a likelihood of continued dedication to the company. They decide the numbers, considering exercise prices, qualified employees, and the allotment of options per individual.

Once the calculations are finalized, the company usually waits for the stock to reach a 52-week high. Then, details about the discounted options are shared. Employees then buy stocks at this reduced price. When employees decide to invest, the company starts deducting the necessary funds from their monthly salaries. This deduction happens from the grant date until the allotment date. Once the required amount is deducted, employees start to own these allotted shares.  

Employees who own more than 5% of the company’s stock are not eligible to participate in ESPP. On the other hand, those with less than specific years of employment – 1 or 2 years, depending on the company- are not eligible for participation. Notably, ESPP is a benefit scheme and there is no compulsion that employees to participate.

Related article: ESPP vs ESOP: Differences Between Equity Linked Compensation Structures

Advantages of Employee Stock Purchase Plan (ESPP)

  • Discounted stock purchase: ESPPs typically offer employees a discount of 5-15% on the fair market value of the company's stock.
  • Potential for capital gains: If the stock price of the company increases, employees can sell their shares for a profit. The amount of profit will depend on the size of the discount and the increase in the stock price.
  • Participation in company success: ESPPs allow employees to participate in the success of the company. If the company does well, the stock price is likely to increase, which means that employees can make a profit on their investment.
  • Tax benefits: In some cases, employees may be able to defer taxes on the discount on ESPP shares until they sell the shares. This can save money on taxes.

Disadvantages of Employee Stock Purchase Plan (ESPP)

  • Stock price volatility: The stock market is volatile, and there is no guarantee that the stock price of the company will increase. If the stock price decreases, employees could lose money on their investment.
  • Vesting period: In some cases, employees may have to wait for a vesting period before they can sell the shares, they purchase through an ESPP. This means that employees may not be able to access their money if they need it in the short term.
  • Taxes: Employees may have to pay taxes on the discount on ESPP shares, even if they do not sell the shares immediately.  

Difference Between ESOP and ESPP

  • ESOP: An employee stock ownership plan (ESOP) is a qualified retirement plan that allows employees to acquire shares of their company's stock through a trust. The company contributes shares of stock to the trust, and the employees then purchase shares from the trust at a discounted price. ESOPs are typically used by privately held companies.
  • ESPP: An employee stock purchase plan (ESPP) is a non-qualified retirement plan that allows employees to purchase shares of their company's stock at a discounted price. Employees contribute a portion of their paycheck to the plan, and the company then purchases shares of stock for the employees at a discounted price. ESPPs are typically used by publicly traded companies.

Bottom Line

Employee stock purchase plans (ESPPs) allow employees to buy shares of their company's stock at a discounted price, typically 5-15%. Employees contribute money from their paychecks to the plan, and the company then purchases the shares for the employees at a discounted price.

FAQs: Employee Stock Purchase Plan (ESPP)

1. Are Employee Stock Purchase Plan (ESPP) tax deductible?

Employee Stock Purchase Plans (ESPP) are not tax-deductible at the time of purchase. Taxes are paid when you sell the stock, with the income being either ordinary or capital gain based on holding periods.

2. Are Employee Stock Purchase Plan (ESPP) given to all employees?

Not necessarily. Companies are not required to offer ESPPs to all employees. Employers typically select participants based on performance and dedication to the company. Eligibility is determined by factors like exercise prices, qualified employees, and the allocation of options per individual

3. Can you transfer Employee Stock Purchase Plan (ESPP)?

No, you cannot transfer your ESPP shares or rights to another person or entity. The shares purchased through the ESPP are issued in your name and are considered your personal property. However, you can sell the stock acquired through an ESPP after meeting specific holding periods and tax implications.

4. What happens to ESPP when you leave?

When leaving your job, there may be several options available depending on the company's ESPP rules. These could include selling the shares immediately, holding onto them until they vest, or exercising any remaining purchase rights before leaving.  

5. Are Employee Stock Purchase Plan (ESPP) worth it?

ESPPs can be worth it for employees as they offer the chance to buy company shares at a discount, typically around 5%–15% below market value. This can provide an opportunity to benefit from the company's growth. Consider the tax implications and holding periods, as selling after 12 months can lead to more favorable tax treatment. Evaluate factors like discount percentage, purchase period, and restrictions on selling before deciding if an ESPP aligns with your financial goals.

Team Qapita

Related Blogs