While participating in an Employee Stock Purchase Plan (ESPP) offers benefits for employees, the company should be aware of complex accounting issues stemming from market volatility. In particular, when an ESPP has more than one purchase period within the same offering period and has a reset or rollover provision, a decline in stock price from the original offering price can be painful—and can significantly impact how equity compensation is accounted for.
As a first step, it's important to ask whether your company's ESPP includes a reset or rollover provision? If so, how is your organization affected by it?
Only plans that have multiple purchase periods per offering period can have reset and rollover provisions. If your ESPP has a single purchase period and offering period, then a decline in stock price will simply adjust your purchase price. However, most plans with multiple purchase periods have a reset or rollover provision to maximize the benefits for their employees. It's important to read the details of your ESPP to understand your provisions.
Reset and rollover features are triggered if the market price of the stock at the end of any purchase period is lower than the stock price at the start of the offering period. You would still complete the purchase as normal in accordance with your plan.
A reset provision in an ESPP allows an employee to purchase company stock during the following purchase period based on the price at the beginning of the purchase instead of the original offering price. As a result, they can purchase stock at the discount of the lower of the price from the beginning of the purchase period or the price on the purchase date (assuming your ESPP has a lookback provision).
When a rollover provision is triggered, the offering period is immediately nullified after the purchase date, and a new offering period is established using the then-current stock price as the base purchase price. Thus, if you had a 12-month offering period with two 6-month purchase periods, you would start a brand-new 12-month offering period after the rollover.
When a reset or rollover takes place, it is a modification for accounting purposes. It is classified as a Type I modification: Probable to Probable. At the time of the reset or rollover, you will need to calculate the fair value immediately before and immediately after to determine the incremental value for each purchase not yet completed within the ongoing ESPP offering. The incremental value is then expensed from the modification date through the purchase periods as a result of modifying the purchase price.
Due to most equity administration system limitations when it comes to ESPP expense, modifications are not seamlessly handled. It is very likely that the incremental expense will need to be calculated and managed outside of the system that is used to administer your ESPP.
In addition to the incremental value, each future purchase will need to take into consideration the incremental shares that will be purchased due to the decrease in the purchase price. When the purchase price declines, participants will be able to buy a greater number of shares than originally estimated. The expense true-up at the time of purchase for the incremental shares will be accrued at the original fair value that was calculated at the beginning of the offering/grant date.
You should be aware of your ESPP pool because when your company's stock price declines, participants will end up purchasing more shares than you may have forecasted. If the price continues to be on the lower side or declines even further, your plan risks running out of shares. This might be the time to add a limit to the number of shares a participant can buy in each purchase period if you do not already have one.
Changes in contributions and withdrawals also impact the final expense. If the modifications resulting from a reset or rollover are not enough, you will need to keep a close tab on terminated participants vs. participants that withdraw from the offering. For terminations, accrued expenses can be reversed. For withdrawals, ASC 718 doesn't allow you to reverse the expenses. Similarly, decreases in contributions are ultimately ignored for participants that don't terminate before the end of the purchase period.
So, is it the right time to consider a new stock valuation? Think about your long-term business goals and short-term employee morale. Whatever way you go, make sure you consider the top pros and cons of new valuations summed up here:
Pros:Don’t forget to include your team of advisors in your decision.
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