Liquidity How and when will employees be able to sell their shares? An essential part of any employee stock ownership program is the ability of employee shareholders to sell their equity. A company establishing an employee equity program has a practical, moral, and, in some cases, legal obligation to create liquidity for employee shareholders at some point.
For public companies, of course, this is not an issue since, by definition, a ready market for the company's stock is available. Likewise, for ESOPs, a system of liquidity for employee stock is prescribed by law. Private company sponsors of ESOPs are required by law to provide liquidity for departing ESOP participants within specified time periods.
A private company that establishes an individual-based program should focus carefully on the liquidity issue when designing its plan. After all, for stock ownership to benefit the employee shareholder, there must ultimately be a market for the shares. Not only is a reasonable liquidity mechanism a matter of fairness and honesty, but a lack of liquidity will negate the value and motivation of employee ownership.
Even though many companies hope to provide liquidity by going public or participating in a lucrative merger, for most companies this is not realistic. Liquidity expectations based on mergers or sales may be legitimate goals, but this tends to be a relatively long-term strategy. In most companies, liquidity for employee shareholders will have to be provided by the corporation itself.
Liquidity is usually not a pressing priority in the early years of the plan, since there has been insufficient time for employees to realize significant appreciation on their shares and the cost to the company to repurchase shares will be lower. It becomes more important, however, as the shares appreciate in value.
There are two main issues relative to providing liquidity for employees. A company needs to consider the cash flow implications of repurchasing stock from employees. In addition, a company should consider providing a mechanism by which employees can sell at least some of their shares while they are still employed by the company, rather than providing liquidity to employees only when they leave the company. Being able to obtain liquidity only when they leave the company may introduce a perverse incentive for employees to leave in order to cash in their ownership stake.
There are various ways for a company to provide liquidity. The simplest method is for the company to make unscheduled purchases of shares as cash flow permits. If the company can establish and fund a reserve cash account for stock repurchases, it may be possible to establish a regular schedule of stock repurchases according to a set program. Many companies establish a priority system, agreeing to repurchase shares from retiring employees first, then from employees departing prior to retirement age, then from current employees as cash permits. These repurchase programs typically include a provision allowing the company to spread the payments over a number of years, with a market rate of interest paid on amounts owed to employees.
One way to provide a high level of employee liquidity is known as an internal stock market. This approach provides periodic trading opportunities at which employees can sell or buy stock as they desire. Rather than having to provide all of the cash to fund repurchases, companies with internal stock markets need only supply enough cash -- or new shares -- to balance the buy and sell orders at each trading opportunity. Note that a true internal market of the kind described here is viewed by the SEC as public trading, even though it is limited to employees of the company, and therefore requires full SEC registration. For this reason, it is feasible only for relatively large corporations that can afford the considerable expense of the registration process and administration of the trading system.
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