Sure, the S&P 500 has almost recovered from the nosedive the market took back in February and maybe your stock price has as well. That’s good news for your shareholders (and your equity program) but increasing stock prices don’t necessarily help much with cash flow.
What can help with cash flow? Your equity program! Here are four ways you can use equity awards to reduce cash outflow for the company.
Paying out less cash compensation to employees leaves more cash for company operations. There are a host of ways equity awards can be used to accomplish this; here are a few examples:
Recent memos from Deloitte and KPMG discuss replacing cash-based compensation with equity.
Every dollar an employee contributes to the company ESPP is a dollar that the company can use for other purposes. Imagine if you could get half of your company’s employees to contribute 5% of their pay to the ESPP: what would that mean for your company in terms of cash flow?
Plus, the financial statement cost for ESPPs (even very generous plans) is typically only a small portion of the company’s overall compensation cost (according to an NASPP/NCEO/CEP Institute survey, less than 3%); ditto for the share usage under the plan (and investors tend to view ESPPs favorably).
Because most ESPPs guarantee a discount off the current stock price, ESPPs can be valuable to employees even during periods of market volatility. A recent blog by Bruce Brumberg highlights Fidelity data showing gains of over 40% for employees who bought stock in their company ESPP in March or April and were still holding that stock in June.
By far, the most common method of covering taxes on RSUs is share withholding, which can place a heavy cash outflow burden on the company. Think about it: withholding shares to cover RSU taxes means that the company is paying out anywhere from 22% to over 40% of the value of vested awards in cash to the IRS. And that’s just the withholding for US employees; if you are using share withholding for global employees, the cash outflow is even higher.
Let’s estimate conservatively: multiply the value of RSUs held by US employees that vested over the past year by 22%—does your company perhaps have a better use for that cash right now? You can’t get back what you’ve already deposited with the IRS, but you can change how you handle RSU tax withholding going forward.
Sell-to-cover is a solution that is cash neutral for both the company and employees. With this approach, a portion of the RSU shares are sold on the open market to cover the tax withholding due upon vesting; the employee ends up with roughly the same net number of shares as with share withholding, but the company gets an influx of cash that can be deposited with the IRS. And the IRS’s recent update of its audit procedures resolves challenges related to the timing of the deposit—see my July 14 blog entry.
Make no mistake, there are other concerns to think about. Two of the most pressing are that the company’s trading volume must be sufficient to absorb the shares that will be sold on each vesting date and Rule 10b5-1 plans may need to be in place to cover vesting dates during company black-outs (or when employees have material nonpublic information).
When equity awards are eligible for dividends and equivalent payments, rather than making these payments to employees at the same time dividends are paid to shareholders, hold employees’ dividends/equivalents until their underlying awards are paid out. This helps cash flow in two ways:
Cash outflow for dividend/equivalent payments can also be reduced by paying out the dividends/equivalents in stock. Where the taxes due on the award and dividends/equivalents are paid via sell-to-cover (or with cash), this would eliminate all cash outflow for the dividends/equivalents.
Changing dividend/equivalent payments on future awards should be straightforward, although some companies may need to amend their plans. For existing awards, it will be necessary to evaluate whether employee consent is necessary to make the change.
There’s always a catch, isn’t there? In this case, it’s additional dilution. The tactics described above all involve issuing additional shares to employees or selling additional shares into the market. In some cases, the dilution might be minimal (e.g., ESPPs and dividends) but in others (additional equity awards, sell-to-cover), it could be significant. Along with forecasting cash flow for each strategy, companies should also consider how many additional shares will be issued.
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