Tuesday, January 17, 2006

The Wonderful World of Employee Stock, Part 1: Getting Started on Owning One Billionth of Your Company

Author: Nick
Category: Money
Topics: ,

Look out! He’s writing a SERIES!!! Head for the hills!

That’s right, the first multi-part adventure finally begins here at Funny Munny. Over the course of the next 82 months (or maybe a few days if I cover everything sooner), we’ll be looking at all the different ways that you and the stock of your employer can interact. You might think it’s as simple as owning or not owning your company’s stock, but it’s far, far more complicated than that. Actually, it isn’t, but if I say it’s easy you’d go read about it somewhere else. So it’s extremely, mindnumbingly difficult and without my help you’ll lose all your money and the SEC will search through your underwear drawer if you even say the word “stock” while at work.

Now that I have your terror-induced attention, we can start talking about all the different ways you can get your hands on a chunk of your company’s stock. First off we–

So what are my options for purchasing stock in my company?

Whoa! Where’d that big bold question come from? No matter, it sets up my first topic very nicely.

There are three common ways for an employee to play with company stock: an Employee Stock Ownership Plan (ESOP), an Employee Stock Purchase Plan (ESPP), or a stock option plan. At first, they sound like the same thing–plans for acquiring stocks. And that’s entirely kinda sorta true not at all. There are some major differences between the three that–

What’s an Employee Stock Ownership Plan (ESOP)?

Okay, Mr. Bold Question Man, if we’re gonna do things like this, you need to wait until I finish answering a question before asking another one.

Sorry. I’m just excited about Employee Stock Ownership Plans!

That’s okay, we’re all just as excited. Anyway, an Employee Stock Ownership Plan is the most common of the three options. Despite having the word “ownership” in its name, ESOPs don’t actually let you own any stock. Instead, an ESOP is a big trust that invests solely in stock contributed by your company to the plan. You still get most of the benefits of stock ownership; if your company does well, your contributions earn more. In return, your employer gets some nice tax savings and maintains control of the business. Contributions you make to an ESOP can be done on a before-tax basis, so they are often combined with a 40l(k) plan. In some cases, your employer will match some of your 40l(k) contributions in part or completely with ESOP contributions.

So then what’s an Employee Stock Purchase Plan? (ESPP)

Unlike an ESOP, the money you contribute to an ESPP is used to directly purchase stock for you. You make contributions to an ESPP over a certain period of time, and at the end of that period, your employer purchases the stock for you. The price you pay for each share is typically either the price at the beginning or end of the period, whichever is lower. As an added bonus, you might even get a discount on the purchase price of the stock–sometimes up to 15%. These discounts often mean that you make a decent chunk of money on your contributions right away since they’re worth the full price of the stock. As such, some people will sell their newly acquired stock immediately for a nice profit. If you hold on to the stocks, you’ll own a tiny part of your company and can vote in certain important business decisions such as board elections and what your boss is having for dinner tonight. Of course, you’ll probably only have a few hundred shares of your company stock compared to the millions that exist, so you won’t want to tap dance naked on your manager’s desk.

And stock option plans? How are those different from ESOPs and ESPPs?

Stock option plans have three important components: a number of options, an option price and a time period during which you can exercise your options. For example, if your company gives you a one-year option to buy a share of stock for $50, and during that year the stock’s price goes up to $80, you can exercise your option at that time to buy a share for $50 and (if you decide not to keep it) immediately sell it on the open market for $80–a $30 profit per share. While you don’t get the voting rights that come with being a regular shareholder or participating in an ESPP, you are protected from losing any money since you wouldn’t normally spend a dime until you exercise your options for a profit.

Of stock option plans, ESOPs, and ESPPs, which one is the best for me and my money?

Usually your best option is the one available to you since it’s rare for a company to offer more than one to all of its employees. If you do have a choice between the three, then your decision depends on your reasons for dabbling in your company’s stock. If you just want to make some money with no risk, stock options will help you do just that. ESOPs are geared more toward long-term investment. ESPPs fall somewhere in between since you can often sell your purchased stock immediately for a profit when you consider any discounts you may receive, or you can hold on to your stocks and possess the same rights (and risks) as other shareholders.

Next time, we’ll get into juicy detail about ESOPs–how they work, things to watch out for, and tips for making the most out of your ESOP experience.

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