1. Employee Stock Plans Kevin Ball Bryce Peterson Adam Wright

2. ESPP (Employee Stock Purchase Plan) What is it? –Employees use after-tax payroll deductions to acquire their company’s stock, usually at a discount (~15%) –Easy and convenient to setup

3. Types Qualified (423) –Only employees of company can participate –Approved by board with 12 month interim –Employees with 5% or greater of stockholding in company cannot participate –All eligible employees must be allowed participation –The purchase price may not be less than the lesser of 85% of the fair market value of the stock 1) at the beginning of the offering period, or 2) on the purchase date –Limit to $25K in purchases per year per employee

4. Types Non-Qualified –Simple payroll deductions allowing stock purchase, sometimes at a discount –No special tax treatment –Not necessarily available to all employees

5. What about taxes? Qualified Plan –When you buy, you don’t owe taxes –When you sell, the discount that you received when you bought the stock is generally considered additional compensation, pay taxes on that as regular income –Any gains are taxable (capital gains tax – usually less than ordinary income rate) < 2years grant date – considered compensation > 2 years grant date – generally considered capital gain –See tax link in sources for more information… Non-Qualified Plan –Difference between fair market value and amount you paid treated as normal compensation and taxed accordingly

6. Household Application Example: –Income of $80,000 –Tax rate: 28% –10% in ESPP: $8,000 –Fair market value: $100 –Discount price: $80 –Shares purchased: $8000/$80 = 100 –Spread: $20*100 = $2000

7. Remember Volatility in company (beta)! Diversify –My father-in-law at HP Risk Tolerance

8. History of ESOP Developed in the 1950’s by Louis Kelso, a lawyer and investment banker. Based on the premise that the capitalist system would be stronger if all workers could own company assets In 1974, the Employee Retirement Income Security Act established statutory framework for ESOPs.

9. ESOP Uses To Buy Shares of a Departing Owner— Departing owners of private firms can use ESOPs to create a market for their shares. To Borrow Money at a Lower After-Tax Cost— ESOPs borrow money to purchase stock and repay loan with tax-deductible contributions (both principal and interest!). To Create and Additional Employee Benefit— Matching employee savings or contributions with ESOP shares

10. ESOP Rules Company sets up a trust fund Contributes new shares of company stock or cash to buy existing shares Alternatively, the ESOP can borrow money to buy new or existing shares, with the company making cash contributions to the plan to enable it to repay the loan Company contributions to the trust are tax-deductible, within certain limits Shares in the trust are allocated to individual employee accounts Generally all full-time employees over 21 participate in the plan Allocations are made either on the basis of relative pay or some more equal formula

11. ESOP Rules Cont. As employees accumulate seniority with the company, they acquire an increasing right to the shares in their account, a process known as vesting Employees must be 100% vested within five to seven years When employees leave the company, they receive their stock, which the company must buy back from them at its fair market value (unless there is a public market for the shares) Employees must be able to vote all issues Companies can deduct up to 25% of eligible pay to defined contribution plans (ESOPs, 401(k), profit sharing, money purchase, and stock bonus plans). The combination of employer contributions and employee deferrals into defined contribution plans (ESOPs, 401(k) plans, etc.) cannot exceed 100% of pay in any one year. This limit is constrained, however, by a second limit, which provides that not more than $40,000 can be added in 2002, a limit that is indexed for inflation in $1,000 increments thereafter.

12. Household Tax Incentives Company contributions are deductible up to 25% of covered compensation. Company can deduct dividends paid on ESOP shares (under certain criteria) Employees pay no tax until ESOP disbursements –59.5 yrs old rule applies –10% penalty for early withdrawal –Can be rolled over into a traditional IRA

13. Household / Small Business Application Evaluate all your alternatives—ESOPs can be very expensive! What is the applicable tax bracket for the company? How will the annual costs compare to the annual contributions? Is our payroll adequate? Do you have more than 20 employees?

14. Creating an ESOP For Your Business Determine whether owners are amenable Conduct a feasibility study Conduct a valuation Hire an ESOP attorney Obtain funding for the plan Establish a process to operate the plan

15. ESOP Drawbacks The law does not allow ESOPs to be used in partnerships and most professional corporations Private companies must repurchase shares of departing employees, and this can become a major expense The cost of setting up an ESOP is also substantial -- $15,000 to $20,000 for the simplest of plans in small companies and on up from there Any time new shares are issued, the stock of existing owners is diluted ESOPs will improve corporate performance only if combined with opportunities for employees to participate in decisions affecting their work

16. ESOP Summary Variety of applications to reduce taxable company income and “incentivize” employees Carefully review the rules and procedures before creating an ESOP Predominantly used in private companies (90% of plans and 60% of participants)

17. Sources http://personal.fidelity.com/products/stockoptions/faqpurchase.shtml http://personal.fidelity.com/products/stockoptions/stockpurchase.shtml http://www.turbotax.com/articles/EmployeeStockPurchasePlans.html http://www.nceo.org/esops/esop_articles.html (February 20, 2003)