Category: General Business News

With 57 percent of public companies offering their workers employee stock purchase plans (ESPPs), according to the National Association of Stock Plan Professionals (NASPP), understanding how qualifying dispositions work is an essential skill.

The concept refers to someone selling or otherwise “disposing” of equities, who sees  advantageous tax benefits. This is especially pronounced when a stockholder’s normal tax income rate differs markedly from prevailing tax rates for long-term investments.

Eligible individuals are those employed by a company that offers such a benefit. There are two different options available for worker participation.

The first option is where employees participate in the ESPP. The second option is through an incentive stock option plan (ISOs). It’s noteworthy to distinguish that the ESPP is for most employees employed after a particular time at a company. However, ISOs are reserved primarily for senior management and executives, such chief financial officers (CFOs), chief executive officers (CEOs), etc.  

What determines if it’s a qualifying disposition is how long the employee keeps the equities prior to the sale.

ESPP Example

If 100 shares are acquired via ESPP, bought via a 10 percent discount to the prevailing offer of $40, the purchase of 100 shares of stock at $36 equals $3,600. If the stock appreciates to $60 in the future, the difference (and capital gain) would be $2,400 in profits ($6,000 – $3,600).

Qualifying Disposition Example

This scenario breaks down how the discount and ultimately how capital gains are treated.

The discount of $4 per share, taxed at the employee’s present wage rate. Depending on the tax rate the employee is taxed at, the liability would be ($4 a share, multiplied by 100, times the tax rate of 30 percent or $120).

Using the ESPP example’s figures, the long-term gain of $24 per share (times 100 shares) is taxed based on the lesser rate of say 15 percent. ($3.60/share times 100 = $360).

Therefore, the entire taxes owed ends up being $120 + $360 = $480.

Non-Qualifying Disposition Example

However, for stock liquidations not meeting qualifying disposition criteria, the $2,400 would see a 35 percent capital gains tax ($2,400 multiplied by 35 percent = $840).

Based on the qualifying versus non-qualifying distribution scenarios, the difference of $360 in capital gains savings represents a stark contrast in tax obligations. Therefore, it’s important to determine how to meet a qualifying disposition.

It requires the following criteria to be met. The stock sale date must occur at a minimum of 12 months from the stock purchase date. It also must be held for at least 24 months from the ESPP offer date or the ISO stock warrant date.

While transactions may differ in the quantity of shares sold and for how much, the timing for workers selling the shares is far less variable. It is important for employers to ensure workers are familiar with the tax implications.

 

Sources

https://www.naspp.com/blog/five-trends-in-espps

Whether you are an investor, an owner, or an internal financial analyst, understanding how the equity multiplier works and how to interpret it is a helpful skill.

Defining the Equity Multiplier

The equity multiplier is a metric that tells the user what percentage of the company’s assets are loaned against shareholders’ equity. The smaller the calculated number for the equity multiplier, the less risky the financing is due to less debt owed by the company. It’s more favorable since there are lower debt servicing costs needed. When liabilities and/or assets change, the company’s equity multiplier changes.

Conversely, the bigger the equity multiplier, the more likely investors will be exposed to financial risk. This is due to the company having more outstanding debt, requiring more cash flows to service ongoing debt repayment, along with normal operations. A good rule of thumb is that anything lower than 2 is good, while anything higher than 2 signifies risk.

Putting It into Context

Since companies obtain financing through a mix of equity, debt, or both, it’s important to measure and monitor how the combination changes over time. Since investors look at the metric, among other financial yardsticks, it can influence how they determine if a company is worth investing in. Investors compare one company to others in the same industry and against historical measures to see how the company rates financially. The equity multiplier is measured relative to past measures, industry standards, or its sector competitors.

The ratio is calculated as follows:

Equity Multiplier = Total Assets / Total Shareholders’ Equity

Both input values are found on the company’s balance sheet, either on the quarterly or annual reports filed with the United States Securities and Exchange Commission.

If a company wants to go public, it can calculate this ratio to determine if its present results are robust for lenders’ review. Say a company has $2 million in total assets and $1.25 million in shareholders’ equity. Based on these numbers, it’s calculated as follows:

= $2,000,000 / $1,250,000 = 1.6  

The equity multiplier in this scenario, which shows a moderate amount of borrowing, may or may not pose an issue for the company’s financial health.

If a business’ total assets are $450 billion, and shareholders’ equity, according to the financial statements, was $150 billion, the company’s ratio is 3X ($450 / $150).

If a different company’s assets are $825 billion with $165 billion of shareholders’ equity, the same resulting ratio is 5X ($825 / $165).

These calculations show that as the ratio of liabilities and asset values adjusts, the equity multiplier also changes because a company uses less debt and more shareholders’ equity to finance the assets. While higher equity multipliers can help companies grow faster, especially during low interest rate and high-growth environments, if borrowing costs rise and/or sales fall dramatically, it can forecast negative growth. Investors favor businesses with low equity multipliers since this indicates the company is using more equity and less debt to finance the purchase of assets.

Regardless of the company or the industry, understanding how the ratio is calculated and used in making investment decisions makes sense for both companies and their potential investors.