Last week I blogged about how a stock price decline could impact your burn rate (and, consequently, your share reserve). A market decline can also have a significant impact on your ESPP.
If the FMV on the purchase date is less than the FMV when employees enrolled in the plan, employees will be able to purchase more shares than if the stock price had increased. If your plan has a lookback, and your FMV declines by 25%, employees will be able to purchase 1.3 times as many shares than if the stock had increased in value (absent a limit that caps purchases). If your FMV declines by 50%, employees can purchase twice as many shares!
The math is the same regardless of actual stock price. You can see how a decline in price could burn through your plan reserve.
If your ESPP allows multiple purchases per offering and automatically reenrolls employees when the FMV on the purchase date is less than FMV at the start of the offering, this problem is compounded because the new lower purchase price will be locked in for the remainder of the offering (or possibly longer).
A limit on the number of shares employees can purchase can help preserve your share reserve. That’s the good news. While it is helpful to have this safeguard in place, the bad news is that employees may be unhappy to discover that their purchases are limited. Employees that hit a limit will usually receive a refund of their excess contributions, meaning they don’t get a return on those contributions. Employees can be understandably upset about this; ultimately it can impact how employees perceive the plan going forward.
When the stock declines in value, more employees are likely to be subject to the $25,000 limit as well. The amount employees can contribute without exceeding the $25K limit will decrease along with the decline in stock price.
For example, when the stock is appreciating, employees can contribute $21,250 per year to a plan that offers a 15% discount ($25,000 multiplied by .85). But if the FMV declines by 25%, any contributions in excess of $15,937.50 will cause an employee to exceed the $25K limit (75% of $21,250). If the FMV declines by 50%, contributions in excess of $10,625.00 will cause employees to exceed the $25K limit. That's half what employees could contribute when the FMV appreciates. You can see how a significant decline in price over your purchase period could cause more employees than expected to be subject to the $25K limit.
Of course, when the stock price is in decline, it is common for employees to withdraw from the ESPP or reduce their contribution level. I’m not encouraging or discouraging this course of action, but it can help mitigate some of the above concerns, so it is something to consider in your forecasts.
If your stock price is in decline, here are a few actions you can take now to be better prepared for the impact on your ESPP:
Lastly—and this has nothing to do with your ESPP—stay healthy, practice social distancing, and stay safe!
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