Understanding ESPP Lookback: How This Opportunity Works in ESPP Plan

Casey Fenton

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Picture being involved in this scenario: Two years ago, Emily joined your company right when the stock was at $40. She saw the potential for growth and immediately enrolled in your Employee Stock Purchase Plan (ESPP). Today, your stock is trading at a robust $80 per share. Because you wisely incorporated a lookback provision into your ESPP, Emily can now purchase shares at the $40 rate she saw on her first day, plus enjoy a 15% discount. She's not just making a casual investment; she's doubling her money instantly.

In moments like this, an ESPP transforms from a standard employee benefit into a life-changing financial opportunity. The lookback provision is the magic ingredient that amplifies this impact, turning your employees into deeply invested stakeholders. Curious? Keep reading to learn how an ESPP with a lookback feature can be a win-win for both you and your employees.

What is ESPP?

An Employee Stock Purchase Plan, commonly known as ESPP, is a company-sponsored program that offers your employees the opportunity to acquire shares of your organization. But this is not just any stock purchase; it's a planned approach facilitated through systematic payroll deductions. Over a specified period—often three, six, or twelve months—these deductions accumulate in an individual account for each participating employee. At predetermined intervals, known as purchase periods, these funds are used to buy company stock.

While the core appeal of an ESPP is its ability to turn employees into shareholders, thereby aligning their interests with the company's long-term success, there are several other benefits as well. For one, ESPPs usually offer shares at a discounted price, making it financially advantageous for your team. Moreover, the payroll deduction system streamlines the process, making it hassle-free and accessible even for those who aren't financially savvy. The deductions are post-tax, meaning there's no immediate tax liability for your employees when they contribute to the plan.

But where ESPPs really shine is in their flexibility. They are often customizable to suit your company’s specific needs and objectives. You can introduce features like waiting periods for new hires, set limits on contribution amounts, or even tie the program to specific performance metrics. This adaptability makes ESPPs a versatile tool for not just employee retention, but also for fostering a corporate culture of shared ownership and collective success.

When Does an ESPP Plan Lookback Happen?

An ESPP typically has an offering period, which is the span during which employees can enroll and contribute to the plan. These offering periods often last for six months or a year and may contain multiple purchase periods. The purchase period is when the accumulated contributions are used to buy company shares. It's at these purchase dates that the lookback provision comes into play.

The anticipated moment happens at the end of each purchase period. At this point, the ESPP takes the stock prices on the first day of the offering period and the last day of the purchase period and compares them. If the stock price was lower at the start of the offering period, the lookback feature ensures that the employee purchases the stock based on that lower price. This is irrespective of whether the stock price has gone up, stayed the same, or even decreased during the offering period.

The precise timing of when the lookback is implemented can be the difference between modest gains and significant financial windfalls for your employees. Most importantly, the lookback provision is not an automatic benefit but needs to be triggered by the purchase. This means your employees have the choice to not execute the purchase if they believe it's not the right time. It adds a layer of strategy and decision-making that empowers your employees, making them more engaged in both the ESPP and, by extension, the success of your company.

The lookback provision acts as a safeguard against market volatility. If the stock price drops significantly during the offering period, the lookback feature can help mitigate the impact, ensuring that employees can still buy at the lower, earlier price. This feature not only maximizes potential gains but also minimizes losses, making it a powerful tool for financial resilience.

Who Can Avail of ESPP Lookback Rates?

Lookback provisions usually apply to all participants in the ESPP. The specifics, however, can vary based on your company's individual plan rules. Whether you make it available for all employees or put in tenure or performance prerequisites is entirely up to you. The broader you cast the net, the more your team will feel included and valued.

ESPP Scenarios for Lookback and Without Lookback Provisions

One of the most compelling ways to understand the impact of a lookback provision is to examine how it functions in real numbers. The differences between having an ESPP with a lookback and without can be quite stark, affecting not just individual gains but also overall employee participation and satisfaction. Let's break down the math.

Scenario Without Lookback

Suppose your company's stock price stands at $50 on the offering date. Over the next six months, the stock experienced a steady climb, reaching $60 on the purchase date. Your ESPP offers a 15% discount to your employees. In this case, they would be able to buy the stock at $51 ($60 - 9), netting them a gain of $9 per share if they sell immediately.

For employees, the potential gain is still notable but is limited to the 15% discount off the current stock price. Also, employees are subject to market volatility, meaning if the stock price goes down, their potential gains decrease correspondingly.

Scenario With Lookback

In the same situation, let's say your ESPP includes a lookback feature. Now, your employees have a choice. They can either buy shares based on the $60 purchase date price or the $50 offering date price. With a 15% discount, they can acquire the stock at $42.50 if they opt for the offering date price. That translates to a per-share gain of $17.50 if they choose to sell immediately after purchase.

The lookback provision can double or even triple the gains, especially if the stock has performed well during the offering period. It acts as a hedge against market downturns, giving employees a chance to still purchase at a lower price if the stock falls.

The Difference in Numbers

Just by adding a lookback feature, you've changed the dynamics of your ESPP:

Without Lookback: $9 gain per share

With Lookback: $17.50 gain per share

That's nearly double the gain, just from this single feature!

Long-term Implications

While the immediate financial gains are attractive, the long-term implications are even more significant. The boosted gains can translate into higher employee satisfaction, increased loyalty, and potentially even higher productivity as employees feel more invested in the company's success. Moreover, the lookback feature can make your ESPP more competitive, helping to attract top-tier talent who see the added financial benefits as a major draw.

Should You Add a Lookback Provision in Your ESPP Plan?

Adding a lookback feature to your Employee Stock Purchase Plan (ESPP) can be a game-changer, but it's not a one-size-fits-all solution. Whether or not to include this provision hinges on a variety of factors that range from your company's financial stability to your broader HR strategy. Here are some key considerations to help you make an informed decision.

1. Company Financial Health

First and foremost, evaluate your company’s financial standing. If your stock has been historically volatile or if the company is undergoing significant changes that could affect stock prices, the lookback feature can be an added risk. Remember, offering stock at a reduced price will dilute the share value, which might not be ideal in certain situations.

2. Employee Engagement and Retention

How important is employee retention to your organization? A look-back provision can significantly up the ante when it comes to job satisfaction and commitment to the company. If you're facing high turnover rates or seeking to attract top talent, this added financial incentive could make a tangible difference.

3. Administrative Complexity

While ESPPs are generally straightforward to administer, adding a lookback feature does introduce an extra layer of complexity. You'll need to track stock prices at multiple intervals and give employees options at the end of each purchase period. Make sure your HR and finance teams are equipped to handle this increased administrative load.

4. Regulatory Compliance

Depending on your jurisdiction, there might be additional legal and financial reporting requirements associated with implementing a lookback provision. Consult your legal team to ensure that you're not just compliant with the law, but also transparent with your shareholders about how this feature could impact them.

5. Cost to Company vs. Employee Benefits

Finally, consider the cost-benefit analysis from both sides. While you're offering the stock at a reduced price, you're potentially gaining a more committed, motivated workforce. Is the trade-off worth it for your company in the long run?

6. Cultural Fit

Not to be overlooked is whether this feature aligns with your company's culture. If your organization values shared ownership and collective success, a lookback provision sends a strong message in line with these ideals.

What Happens if My Employees Miss the Lookback Provision?

If your employees don't take advantage of the lookback provision, they'll purchase the stock at the current market price minus any applicable discount. They don't lose out entirely but miss the extra benefit the lookback would have provided. Educate your employees about how the lookback feature works and its benefits to ensure they make the most of this opportunity.

How Can Employees Buy Shares Through a Lookback Provision?

1. Enrollment and Contribution

The journey starts at the enrollment phase, where employees decide to participate in the ESPP and allocate a percentage of their post-tax salary for contribution. Make sure your employees know they're setting up for a significant opportunity, especially if your ESPP includes a lookback provision.

2. Tracking Stock Prices

Over the course of the offering period, it's a good practice for employees to keep an eye on the stock prices, although the lookback feature offers a safety net. Some companies provide tools or dashboards for employees to track these prices, so consider adding this utility to your HR technology suite.

3. Decision Time: Purchase Date

The crux of the lookback provision comes into play on the purchase date. At this point, your HR or finance department typically sends out a notification to all participants about their purchase options. The employees can then decide to buy shares at the lower of the two prices: the stock price at the beginning of the offering period or the price at the end. Remember, the 15% discount (or whatever your company offers) applies to this already potentially reduced price, amplifying the benefits.

4. Executing the Purchase

Most ESPPs automate the purchase process. However, given the choice introduced by the lookback provision, you might allow a small window for employees to manually confirm their purchase decision. It is crucial to make this process as straightforward as possible to ensure maximum participation. Offering a step-by-step guide or even a quick tutorial could simplify this crucial stage for your employees.

5. Post-Purchase Actions

Once the purchase is made, employees have several options. They can hold onto the shares, hoping for further appreciation, or sell them immediately to realize quick gains. Each choice has its own tax implications, which should be clearly outlined in the ESPP documentation. You might even consider offering financial education sessions to help your employees make informed decisions.

6. Repeat for Future Offering Periods

It's essential to communicate that the lookback provision isn't a one-time opportunity but recurs with each new offering period. This regularity could affect an employee's long-term investment strategy, and it's an additional feature you can market when explaining the benefits of your ESPP.

Bottomline

Adding a lookback provision to your Employee Stock Purchase Plan is more than just a perk; it's a strategic move that can pay dividends in employee satisfaction and retention. By understanding how the lookback feature operates, you can better educate your team, enabling them to maximize their financial gains. And as they win, so do you, by creating a culture that values and rewards long-term commitment and collective success.

Alternatively, you can find a more flexible option in Restricted Stock Units (RSUs). These are not purchased, but rather a promise of equity ownership upon vesting—virtually at no upfront costs! Book a demo with Upstock today and see how RSUs ties employee rewards with company goals.

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ABOUT THE AUTHOR

Casey Fenton

Founder, Upstock & Couchsurfing, AI and Equity Innovator

Casey Fenton, the founder of Upstock & Couchsurfing and an AI and equity innovator, has revolutionized how we perceive and implement equity in the workplace. His foresight in creating platforms that not only connect people but also align their interests towards communal and corporate prosperity has established him as a pivotal figure in technology and community building. Casey speaks worldwide on topics including ownership mindset, worker equity, With Upstock and Couchsurfing, he has demonstrated an unparalleled expertise in harnessing technology for the betterment of community interaction and organizational benefits.

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