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Qualified Employee Stock Purchase Plans Qualified employee stock purchase plans (ESPPs), also known as Section 423 plans (from the Tax Code section that sets out the rules for them), allow a company to make its stock available to its employees for purchase at advantageous terms. Employers are permitted to offer their stock through such programs at a discount of up to 15 percent from fair market value. To qualify as a Section 423 plan, the opportunity to purchase stock must be made available to virtually all of the company's full time employees who have been with the company at least two years. As with qualified stock option plans, employees will receive favorable capital gains tax treatment on the stock purchased through a Section 423 plan if they hold the stock for at least two years after the purchase opportunity is made available to them and one year after they actually purchase the stock.
These plans are used primarily by public companies because they have the following deterrents for smaller, privately held companies:
- Securities registration rules may be too restrictive
- The costs associated with running a qualified plan may be too high
- Privately held companies usually lack a well-established value for their shares
- Most employees are reluctant to pay cash for shares that are relatively liquid
An employee's decision to purchase stock that is made available to him or her under a Section 423 plan is purely voluntary. The plans are structured to allow employees to pay for the shares through payroll withholding. Because employees are required to pay "up front" for the shares they buy, an employee stock purchase plan will never result in complete participation. It also will not result in the transfer of a large amount of a company's equity to its workforce (as compared with other employee ownership plans). These plans can make an excellent "add-on," or second plan, which, when coupled with another employee ownership vehicle, gives employees the opportunity to invest further in the company -- and it has the notable advantage of raising capital for the company, rather than consuming it. Employees who participate in this type of stock purchase plan also immediately become, to the extent of their investment, "at-risk" investors, thereby increasing their interest in the company's success.
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