As the COVID-19 pandemic continues to take its toll on businesses, employers are searching for ways to strike the balance between cost cutting and rewarding employees.
Large, publicly traded companies experiencing financial strain could find some relief in their employee stock participation plans (ESPP), which allows employees to purchase company stock at a discount of usually 15%. Employees contribute to the plan through payroll deductions. Often times, however, these plans only appeal to highly compensated employees, which is why only about 30% of employees with access to these plans participate in them and an even smaller percentage maximize their allotted $21,250 per year contribution.
Aaron Shapiro is hoping to improve those statistics. Shapiro’s company, Carver Edison, is a New York City financial technology startup that provides interest-free loans to workers who are unable to set aside money from their paychecks to buy their company’s discounted stock. Carver’s business model hinges on its ability to capture a portion of an employee’s stock gains above a certain threshold and then using that to sell options contracts to banks.
Shapiro feels Carver is in a unique position to assist employers that want to reward and compensate their employees during difficult times, but don’t have the necessary cash flow to make that reality.
“What’s happening in the world right now is really interesting,” Shapiro said. “The big companies like the Amazons of the world that have billions and billions on the balance sheet are just going to give everyone raises. But for everyone else, what they’re looking for is a combination of how they can strengthen their balance sheet [to] protect against an uncertain economic future, while at the same time, delivering compensation to employees. Cashless participation does exactly that, it just so happens that it does that in the form of employee stock purchase plans.”
The “cashless participation” variable Carver is able to offer employees became more appealing thanks to an Internal Revenue Service private letter ruling in December of 2018, which determined that companies can let employees benefit from Carver’s loans without jeopardizing the tax-exempt status of their ESPPs.
“Because of cashless participation, employees can now own more stock than ever that they didn’t pay anything for,” Shapiro said. “Most employees who participate in a regular stock purchasing plan would have to see the stock price go down more than 50% before they start losing money on their investment. Even in a volatile market, what cashless participation does is it dramatically reduces the risk of participating for employees that would still participate in a regular ESPP, but now their risk profile is dramatically reduced.”
The Los Angeles Times illustrated what this process would look like. An employee making $34,000 a year is allowed to contribute as much as 10% of each paycheck over six months to buy stock at a 15% discount at the end of that period. However, they can only afford to set aside 5% of their pay — or $1,700 — and elect to use a Carver Edison loan for the rest.
The company’s stock price was $100 on the first day of the six-month period and $140 on the final day. If the ESPP has a lookback provision, the 15% discount is applied to the lower of the two. So, on the final day, the worker’s $1,700 in deferrals plus an equal-size loan from Carver will be enough to purchase 40 shares for $85 apiece. That’s an instant 65% gain.
Carver will then immediately sell enough of those shares to cover the loan. In cases when the stock price increase over the six-month period exceeds a certain threshold — say 25%, or $125 in the example above — Carver will collect and sell a few extra shares. Some of those may be sold in the open market, while others will be sold to banks via options, allowing Carver to generate revenue by collecting a small fee on each contract.
The idea behind using part of the gains to sell options is “to have the market makers pay the bills for factory-floor workers to have more money in their pockets,” Shapiro told the Times.
In the end, the employee will end up with 26.4 shares, worth about $3,700, that are theirs to keep or sell. Had they elected to forgo a Carver loan, they would have been left with 20 shares worth $2,800.
Shapiro said Carver also provides educational material to employers to increase participation among workers as part of its offering. Carver, which recently announced a partnership with E*Trade, produced a study with the financial services company that looked at six-month periods of returns from the S&P 500 since 1964 and found that employees utilizing cashless participation instead of investing in the stock market on a broad basis would have realized a 40% annualized difference in returns.
Given this data, Shapiro is hopeful companies will see this as another way to assist their employee base during the COVID-19 pandemic.
“This takes all of the stuff you’ve been hearing from companies around solving for inclusion and economic justice, but also does it in a way that looks after shareholder interest as well and brings it all together,” Shapiro said. “It’s something tangible that companies can do right now, because most companies have these plans, that’s simply a matter of flipping a switch to actually act on a lot of the things these companies have talked about.”
About the Author
Brett Christie is the managing editor of Workspan Daily.