Maximizing Equity Plan Share Reserves

Are you feeling the pinch when it comes to the number of shares that remain available for future grants in your long-term incentive plans? Here are a few strategies to prolong a request for a new allocation of shares to your plan.

Size Grants Using a Multiday Average

Because most public companies use a value-based approach to determine grant sizes, volatility in your stock price can have a significant impact on share usage under your plan. In periods when your stock is in decline, your burn rate can skyrocket.

Determining award size using a multiday average price, rather than a single day or “spot” price can help mitigate this concern. A 20 to 60-day average price can help smooth out the impact of market volatility on award sizes (the longer the averaging period, the less variability there will be in grant sizes). This average is used only for purposes of determining how many shares will be granted; award fair value for accounting purposes is still based on the grant date FMV, and the exercise price of stock options is still equal to the grant date FMV.

This is an excellent practice regardless of whether your stock price is up or down. Not only does it make your burn rate more predictable, it also mitigates inequities between employees. We’ve seen an increased interest in this approach. In the NASPP/Deloitte Tax 2022 Equity Administration Survey, the percentage of respondents using an average value to size grants increased to 42%, up from just 27% in 2019. 

Limit Exceptions to Your Grant Guidelines

Almost all companies have established guidelines that govern grant sizes. Inevitably, managers will request exceptions to these guidelines. Implementing a rigorous process by which these exceptions are requested, reviewed, and approved can be an important tool in managing your burn rate.

Require managers to develop a business case to justify the request (you might provide a form to assist them with the process and to ensure that they fully document the rationale for their request). Determine who will review the business case and ask them to develop a framework for evaluating the requests. It might be a good idea to establish a committee, perhaps made up of high level individuals in HR and accounting/finance, to review and approve the requests. Ensure that the individuals approving the requests have adequate information to evaluate the request within the larger context of the company’s share usage, such as the company’s current burn rate and how it compares to prior periods.

It also might be helpful to keep a record of all exception requests made by each manager and to evaluate these requests on a year-over-year basis. Managers that make a large number of such requests or that request excessively large grants might need additional feedback or training.

Cap Your Burn Rate

One way to manage your burn rate is to set a flat cap on the number of shares that can be granted per employee. The cap can be graduated based on rank, job title, salary grade, etc.

If you’ve recently experienced a decline in stock price that is creating havoc with your burn rate, reducing the size of grants during the period of the downturn is a potential solution. There are several ways this can be accomplished:

• Reduce grants for all participants by a specified percentage, e.g., grants this year will be equal to only 80% of the value awarded last year.
• Rather than sizing grants using the current low stock price, simply keep grant sizes the same as last year’s grants.
• Set an overall cap on the aggregate number of shares to be granted and adjust individual grants accordingly.

Inducement Grants

Inducement grants are essentially a get-out-of-shareholder-approval-free card and they can be a great tool for preserving your share reserve.

As I’m sure most of my readers are painfully aware, it is virtually impossible for public companies to issue equity awards outside of a shareholder-approved plan. One significant exception to the shareholder approval requirement is inducement awards. These are awards that are granted for the purpose of encouraging individuals to accept an offer of employment. Under both the NYSE and Nasdaq listing requirements, these awards are not subject to shareholder approval.

This almost seems too good to be true, but there are some catches:

• The grants must be issued to newly hired employees. Inducement grants can’t be issued to existing employees (even if you are trying to induce them to stay) and can’t be issued to nonemployees.
• The terms of the award must be communicated prior to the individual’s acceptance of the employment offer or as part of the hiring process.
• The award must be approved by independent directors. In light of Delaware’s relaxation of its approval requirements for equity awards, your board may have delegated authority to approve grants to an officer, other individual, or a committee. That approval process can’t be used for inducement grants.
• There are some required disclosures that must be completed.
• There are securities law considerations to address (the Form S-8 filed for your shareholder-approved plan might not cover these awards).

But even with these considerations, inducement grants are a great ace to have up your sleeve when your plan is running low on shares.

Offer an ESPP

Another great idea to alleviate some of the pressure on your long-term incentive plans is to implement an employee stock purchase plan. ESPPs can offer a fantastic economic benefit to employees and share requests for ESPPs generally aren’t subject to the same level of investor scrutiny that requests for other equity plans are.

And ESPPs are on the rise, both in terms of prevalence and plan benefits. In the NASPP/Deloitte Tax 2024 Equity Incentives Design Survey, the percentage of public companies that offer an ESPP increased to 57%, up from 49% in our 2021 survey. In the NASPP/Deloitte Tax 2023 ESPP Survey, the percentage of ESPPs that offer a 15% discount and that offer a lookback increased significantly.

Share Withholding

When shares are withheld to cover taxes, it may be possible to recycle those shares back into the plan. Although share withholding will result in cash outflow for the company, having the additional shares available in your plan may be an acceptable trade-off. If employees currently sell shares to cover their taxes, switching to share withholding can enable you to reroute shares back into the plan that would otherwise have flowed into the market as a result of those sales.

And, since 2016, shares can be withheld to cover taxes at the applicable maximum individual tax rate without triggering liability treatment under ASC 718. Thus, where employees are interested in requesting additional tax withholding, this could enable more shares to be recycled into the plan.

Note, however, that the IRS has specific procedures for companies to follow when withholding taxes on supplemental payments in excess of the flat rate. See the NASPP Essential Article “Excess Tax Withholding: What You Need to Know” for more information.

Another caveat here is that the plan generally must specifically stipulate that the shares withheld for taxes will become available for grant again under the plan. Companies obviously cannot recycle withheld shares if prohibited from doing so under the terms of the plan. 

Moreover, ISS considers recycling of shares withheld to cover taxes to be a liberal share recycling policy, which reduces the number of points the plan can earn under the ISS Equity Plan Scorecard. This could have the effect of reducing the share allocation for the plan that will receive a favorable ISS recommendation. When adopting a new plan or amending an existing plan, companies should model the effect of the liberal share recycling policy to determine whether the shares that are expected to be recycled will exceed the additional shares that could be allocated to the plan if the plan did not allow recycling.

Consider Cash Payments

An obvious way to extend your plan reserve is to pay employees in cash, rather than equity. Cash-settled awards and stock appreciation rights can mimic the economic benefit of equity awards without requiring the company to issue shares.

Of course, there are significant drawbacks to cash awards, most notably that they will be subject to liability treatment under ASC 718 and can result in significant cash outflow for the company.