Why You Should Participate in Your ESPP at IPO
Employee Stock Purchase Plans (aka ESPPs) are one of the best employee benefits companies offer to their employees. ESPPs are usually provided by companies that are traded on the stock market. In the tech industry, over 85% of companies offer ESPPs.
This means that if your company is about to IPO, it’s likely that your company will offer an ESPP to its employees starting from the moment your company IPOs.
With that in mind, we’re often asked, Should you participate in your ESPP at IPO? And how much should you contribute to your ESPP at IPO?
In this article, we’ll provide a brief overview of how ESPPs function at IPO, some pros and cons of participating in your ESPP at IPO, and we’ll discuss an example from a semi-recent IPO (Airbnb).
The ultra-short answer is that it’s usually worth joining your ESPP at IPO.
How Does an ESPP Work at IPO?
Just like any ESPP, a company’s ESPP at IPO will provide its employees with the ability to purchase company stock at a discount every few months. The big difference with an ESPP at IPO is that once a company goes public, the IPO price will be the price used to kick off the ESPP. This affects how the purchase period, the offering period, and the lookback feature all work together. We’ll explain further.
ESPP Purchase Period at IPO
An ESPP’s Purchase Period is a period in which you set money aside with each paycheck to save up to buy company stock at the end. An ESPP’s purchase period at IPO will typically begin as of the IPO date.
Most companies choose to have purchase periods that last 6 months, but it can be longer.
Normally with an ESPP, you will be informed well ahead of time when you can participate in the ESPP. However, if your company is going public, the timing of the ESPP’s purchase period at IPO will be communicated over a much shorter period. This is because IPOs can take a long time to happen but usually happen quickly once all filings have been made.
ESPP Offering Period at IPO
An ESPP’s Offering Period is the period in which the company will let ESPP participants purchase company stock at a discount. The offering period is often the same length of time as the purchase period, but in some cases, it’s longer.
For example, Apple’s ESPP has offering periods and purchase periods of 6 months. Adobe’s ESPP, on the other hand, has an offering period of 24 months with 6 month purchase periods within that offering period.
With an ESPP at IPO, the offering period will begin on the IPO date and will typically use the IPO price as the beginning offering period price.
Here’s what it would look if your company were to offer an ESPP at IPO with 6 month offering periods and 6 month purchase periods:
ESPP Discount and Lookback at IPO
The best part about ESPPs is that they give participants a chance to purchase company stock at a discount. The discount companies usually offer is 10 to 15 percent. (The most recently IPO-ed companies have offered a 15% discount with their ESPPs at IPO.)
It’s a common misconception for people to think that this 10-15% discount alone is the primary benefit that accounts for the gains ESPPs can provide, but this is not true. If your company also offers a Lookback feature, you’ll be able to apply that discount to either the company’s stock price at the beginning of the offering period or at the end of the purchase period. And this lookback feature combined with the discount can lead to gains much greater than 15%.
Here are a few examples to illustrate what this can mean for potential gains whether your ESPP at IPO goes up, stays flat, or goes down after 6 months:
As you can see, if the stock value of your company only goes up from the time of IPO, you’ll be able to reap a much larger gain than just the 15% discount. In fact, because of the way the math works, the smallest percentage gain you’ll experience while participating in this example ESPP at IPO would be 17.65%.
Pros of Participating in Your ESPP at IPO
Now that we’ve covered how an ESPP operates after an IPO, it’s time to consider the pros of participating in your company ESPP at IPO.
Pro #1 - Provides you an easy way to purchase company equity at or below the IPO price
If your investing is not automated, purchasing stock requires significant thought and effort. When you participate in your company’s ESPP at IPO, it creates an easy way for you to accumulate company shares without having to even think about it. Before the IPO, you can select how much you’d like to contribute. Then, from the moment of the IPO on, you can begin setting money aside from each paycheck to purchase company stock.
Pro #2 - Provides a way to obtain more company equity if you’re planning on selling RSUs after the IPO lock-up
If you have Restricted Stock Units (RSUs), there’s a good chance that the vested portion will (1) become taxable to you either immediately at IPO or (2) once your lock-up expires. (Lock-up refers to the period of time following an IPO where employees aren’t eligible to sell company stock.)
In either case, it’s very common for companies to withhold shares to cover most of the taxes owed. It’s also very common for people to sell a portion of the RSUs that became taxable.
Whether you’re having shares of stock withheld or you decide to sell a portion of them, participating in your company’s ESPP at IPO will provide you with an easy way to obtain more company stock.
Pro #3 - Provides massive upside through the first offering period
A company’s stock price following an IPO can fluctuate widely, sometimes the fluctuations sometimes they are negative, sometimes they are positive, and other times they are extremely positive.
An ESPP gives you exposure to the upside, while limiting a lot of the downside.
For example, if your company’s stock price only increases from the IPO date and there’s a lookback feature, you’ll be able to purchase company stock for the much cheaper IPO price price. It creates an easy pool of funds to use for diversifying, paying taxes, or accomplishing other goals you have.
Pro #4 - Even if the stock price goes down after IPO, you can still have a gain
Many companies have performed well since their IPOs, but there are a handful that haven’t. A big benefit of participating in your ESPP at IPO is that even if the stock price drops 50%, you’ll still be able to apply the ESPP discount to whatever the current price is at the end of the first purchase period.
So although it may be sad to watch your company’s stock price go down for a few months, you should feel a little better that you’ll still be able to purchase company stock and lock in a 15% discount (which amounts to a 17.65% gain).
Pro #5 - You can sell immediately after purchase and use the cash elsewhere
One of the big benefits of participating in your company ESPP at IPO is that once you’ve purchased discounted stock, you can sell your shares and use the cash however you please.
Selling immediately after purchase is considered a ESPP Disqualifying Disposition, which often means that your gains will be taxed at regular tax rates rather than long-term capital gains tax rates.
Once you have cash available, you’ll be free to use it in whatever way you feel best. You can pay down debts, set money aside for a downpayment on a house, or reinvest the cash in a more diversified way.
The tradeoff of paying a little more in taxes in order to lock in gains and use the cash elsewhere is usually sound financial practice. (Please refer to our previous article describing how to determine when to sell ESPP shares.)
Cons of Participating in Your ESPP at IPO
Even though there are lots of benefits to participating in your ESPP at IPO, there are also a couple of drawbacks worth consideration.
Con #1 - Participating in your ESPP at IPO means owning even more company stock
If you’ve been working at a company that’s about to IPO, there’s a strong chance that you’ve accumulated company equity. If you’ve been working at this particular company for a long time, there’s a chance that you own a lot of company stock.
Being so heavily invested in one particular company, you’ll feel the swings in stock price more than most people. If your company’s stock price only increases, you’ll be in great shape. However, if you continue to put all your money into your company’s stock, then your future investment success may be overly dependent on how that company performs. And if you’re already heavily invested in your company, participating in your company’s ESPP at IPO will only lead to owning more company stock.
Putting a plan in place to sell shares you’ve acquired through your company’s ESPP, can offer some protection and turn this liability into a benefit. We understand that this can be a tough issue to grapple with, especially if your company has recently IPO-ed and you anticipate greater company growth and stock performance.
Con #2 - The money is tied up until the end of the purchase period
Each individual's financial situation is different and we know that it can be challenging to make the most of your ESPPs, especially if your living expenses require most of your paycheck. Participating in your ESPP means that you’ll have to set aside some percentage of your paycheck to buy company stock at the end of the purchase period (which is usually 6 months).
If contributing to your ESPP at IPO is going to cause too great a financial strain and/or cause you to rack up credit card debt, it may not be worth contributing.
However, if you can manage to contribute, once you’ve sold shares from the ESPP, you’ll have more cash than you would have if you hadn’t contributed. You can then use that cash to improve your financial situation and meet other important financial goals.
Example of Airbnb’s ESPP at IPO
Now that we’ve covered how an ESPP works at IPO, as well as the pros and cons of participating in an ESPP at IPO, let’s take a look at how Airbnb’s ESPP performed after 6 months of going public.
Airbnb gave employees a couple weeks to opt into their ESPP at IPO before they officially went public.
Its ESPP offers a 12-month offering period filled with two 6-month purchase periods. Its ESPP also offers a lookback, which means if the price only goes up, ESPP participants can purchase Airbnb stock for the IPO price.
Here’s what it would look like if you were an Airbnb employee participating in the ESPP since the IPO:
Airbnb IPO-ed on December 9th, 2020 at $68 a share.
December 10th, 2020 was the first day of trading and shares immediately spiked to $144 a share. A single-day increase of over 110%.
The stock price stayed volatile, but at the end of the first purchase period, Airbnb’s stock was valued at $141.20 per share.
This means that rather than paying $141.20 per share, those participating in Airbnb’s ESPP at IPO would have been able to purchase Airbnb stock for 15% off of $68… or $57.80 a share!
If you had managed to contribute $10k to Airbnb’s ESPP in the first 6 months, this means that you would have spent $10k to purchase 173 shares that would actually have been worth $24,427.60.
Here’s what all this looks like in a table:
As you can see, those who participated in Airbnb’s ESPP at IPO were handsomely rewarded after just 6 months. What’s even more crazy is that Airbnb offers a 12-month offering period, so since Airbnb’s share price continued to rise, Airbnb’s ESPP participants were able to benefit again from participating in the ESPP at IPO.
Our Thoughts on Participating in Your ESPP at IPO
The biggest determinant to whether or not you should participate in your company’s ESPP at IPO comes down to your cash flow. If you need cash now vs in 6 months, then you may want to wait to participate.
That said, in most circumstances, it makes the most sense to max out your contributions to your ESPP at IPO since there’s a possibility for large gains at at least a 15% discount.
There are lots of variables to consider when managing your ESPPs. We recommend reading our article “How Much Should I Contribute to My ESPP” to get a better sense of what will work best for you. If you want to model out how participating in your company ESPP at IPO will affect you, we’ve built a free ESPP Gain and Tax Calculator to make it easy.
Thanks as always for reading. If you have any questions, you’re welcome to reach out to team@equityftw.com.