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When is it worth buying employee shares?

I am repeatedly asked by customers about buying employee shares. Since I mainly work in the Rhine-Neckar metropolitan region, a large proportion of our customers work for listed companies such as SAP, AbbVie or BASF. Almost all major stock exchange companies allow their employees to exchange part of their salary for shares in the company. This naturally raises the question: Is it worth buying employee shares? Clear question, clear answer: It depends. In this article, I would like to briefly describe the criteria that are important for such a decision. The personal situation of each individual cannot be taken into account. Risk appetite and investment objective are also not taken into account. This can only ever be done in an individual consultation.

Table of Contents

Participation of the employer

As the first and most important criterion, the model of employee participation should be examined closely. How exactly does the employer support its employees in purchasing the company's shares? Does such support even exist and how high is it?

Essentially, there are two prominent models:

  1. Discounts on purchase: Here the employee gets the shares at a discounted price. The designs are varied and individual for each company. Often there is simply a discount on the current purchase price, eg 20%. Or the employer guarantees the purchase at the lowest prices in a certain period of time.
  2. Share Matching: Here, the employer, usually after a certain holding period (see below), adds another free share for a certain number of shares purchased. For example, for every three shares that the employee has bought and held for five years, he or she will receive one more for free. Attention must be paid to when such a share is allocated. The earlier the better for the employee.
  3. Of course, a combination of the two models above is also possible.

A large part of the financial advantage for the employee depends on the amount of support provided by the employer.

“At the level of all DAX companies, an average return of 5.2 percent per year was achieved over a ten-year investment period from 1996 to 2017 without employer or state subsidies. Including one free share granted for every three shares purchased by the employer (3+1 matching ratio) and the maximum government subsidy of 360 euros, the annual return increases to 9.2 percent.”[1]

If there is no support (neither from the employer nor from the state) when buying the company shares, in my opinion the disadvantages far outweigh an investment in cheap and broadly diversified equity funds. However, most large companies encourage the conversion of salary into company shares significantly.

holding period

Holding periods may be prescribed for the shares purchased in this way. The employee is thus obliged to hold a share for a certain period of time, for example five years. With this, the employer wants to ensure that the employee is interested in the long-term success of the company and does not just want to benefit from the discounts granted in the short term.

In the Rhine-Neckar region, there are companies that do not require a holding period at all, through to companies that require a ten-year holding period.

In general, the shorter the holding period, the better for the investor. When purchasing employee shares, the employee converts part of their salary into shares. If these shares can only be sold with a delay, he can only dispose of his salary with a delay. This means that the money cannot be used for other investments or consumption. This is a clear disadvantage of some employee share schemes.

A fair compromise between the employer's interest in a long-term investment and the employee's desire for flexibility is a model in which there is no obligation to hold, but there is a reward in the form of free shares for holding for a certain period (cf Share matching above).

I will explain which other much more important disadvantage there is later when considering the asset structure.

tax benefit

For the purchase of employee shares, a state subsidy of 360 euros per year can be claimed on the non-cash benefit. Should this amount otherwise expire, this naturally means a greater increase in wealth for the investor after taxes. So in many cases there is more net than the gross.

The monetary benefit is calculated as follows:

Booking price – exercise price = non-cash benefit

The booking price is the value at which the share is credited to the securities account. The strike price, the price at which the stock was purchased after deducting any discount. Only if the difference between the two values exceeds the amount of 360 euros is a monetary benefit taxable.

Third, asset structure

The biggest and often underestimated downside of employee stock ownership is the strong concentration of wealth in a single company. Under certain circumstances, up to 10% of the salary can be converted into shares. This item in the list of assets is saved more than almost any other. As a result, a disproportionately large part of the wealth is in one stock. That such a concentration is not good needs no further explanation.

I would like to dispel one myth at this point. I occasionally hear the argument that investing in individual stocks yields a higher return than investing in a broadly diversified stock portfolio. This claim is simply wrong. The expected return on a single stock of a given asset class is the same as that of the asset class as a whole.

human capital

It is often forgotten that the wealth structure of most people does not only consist of monetary values, but that so-called human capital also makes a significant contribution to total wealth. Through training and professional experience, the value of the workforce is constantly increasing. In most cases, however, the value of this human capital is highly correlated with the success of the employer or at least the industry.

A biochemist with a degree and relevant professional experience will be able to achieve a significantly higher salary in a pharmaceutical company than in a construction company. Personal success and career opportunities are therefore related to the success of the company or the industry. If at the same time a large part of the investment success is linked to the weal and woe of the same company, the investor takes a double risk.

Such a cluster risk should be avoided or kept small as far as possible. It therefore makes sense in most cases to sell employee shares immediately after the holding period and exchange them for a broadly diversified portfolio.

Feature: property

I would like to end with one last special constellation. As soon as a property is bought in a region that is very much characterized by the success of an employer, the phenomenon of wealth concentration described above increases and there is a very unfavorable risk diversification.

Then not only does a large part of your portfolio assets and your human capital depend on the success of your company, but also the value of your property.

Conclusion

Most participation programs through employee shares are worthwhile for the employee! In most cases, however, the shares should be exchanged for a more diversified share portfolio after the subsidy has been exhausted.

Important details are the support provided by the employer and the design of the model. Long holding obligations can be accepted, but they represent a considerable disadvantage.

Due to the spread of risk, it is often worth selling employee shares as quickly as possible and converting them into a cheap and broadly diversified share portfolio. Personal risk appetite and specific investment goals are always important and not considered in this article. Special feature: If there is a property in a region whose value depends heavily on the employer, then the risk increases.

Disclaimer

Past performance is no guarantee of the future development of the value of an investment. All information and figures in this article are for illustration purposes only. The article is aimed at the general public, but not at individual persons or investors, not even at existing or future customers of InVertas GmbH in particular. In no case is this article or the information contained therein financial advice, investment recommendation or offer within the meaning of the German Securities Trading Act. This information cannot and should not replace individual advice from persons qualified for this purpose. We check information very carefully before publication, but cannot guarantee that all information is correct.

[1] See the triangle of returns on employee shares: Why shareholding programs are worthwhile for employees, employers and society. p. 5.; Available at: https://www.hkp.com/cms/upload/Report_Renditedreieck.pdf

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