Meet The Startup That Is Offering Loans Against Employee Stock Purchase Plans

The quest to find things to borrow against continues. 

After his mom missed out on a life-changing opportunity, Aaron Shapiro decided he was going to re-think employee stock purchase plans. His mom had asked the finance major about an employee stock purchase plan she had the option of investing in years ago that she declined to invest in it because she wasn't able to part with the money up front, according to Bloomberg

When Shapiro read the the prospectus for his mother's ESPP at UnitedHealth, which allowed its workers to buy shares twice a year at a 15% discount, he realized his mom had missed out on millions. At UnitedHealth's ESPP, there was no minimum holding, which meant that employees could immediately arbitrage the 15% discount that the company offered. 

Shaprio said: “It’s arbitrage in its purest form. The money was just sitting there and could have been hers, if she’d just been able to afford payroll deductions.”

And so Shapiro decided to take this experience and use it to start Carver Edison, a company that provides interest free loans to workers who are unable to set aside money from their paychecks to buy into their employee stock purchase plans. His start up cleared a regulatory hurdle in December when the IRS determined that companies can let employees benefit from his loans without jeopardizing the tax exempt status of the ESPP. 

Now Shapiro is looking to persuade some of the 4000 US companies that offer these plans to use his services and boost participation in the plans. His business model works by capturing a portion of the employee's stock gains above a certain threshold and using that to sell options back to banks. Shapiro said that in all cases, the worker ends up better off with one of his loans than without it.

In fact, HR firm Aon struck a deal with him this year to present the concept to corporate clients. Those who advocate for ESP plans say that they align the interests of workers with shareholders and claim that they are a tool to help curb income inequality. As wages have remained relatively stagnant, investments in equities have paid off handsomely, with the S&P 500 returning about 220% over the last two decades.

Those who buy into these plans generally set aside part of every paycheck to buy shares at preset dates. The shares are bought at a discount of as much as 15% to the market price at the start or end of each pay period, whichever is lower. Some companies require workers to hold the shares for a certain amount of time, but many allow employees to sell them immediately.

Despite this, only about 33% of workers actually participate in these plans. Corey Rosen, who founded the nonprofit National Center for Employee Ownership said: “It’s nuts. You’re guaranteed a return except for in very rare circumstances. And you could end up doing quite well.”

Some workers may opt out because they don’t understand the plans or because they prefer taking the cash up front instead of deferring it. However, the biggest barrier remains that most can’t afford to set aside the money for it.

This is where Shapiro's business model comes in. By using leverage, he offers an opportunity to increase gains without the downside risk. Bloomberg laid out an example of how it works:

An employee at a manufacturing company making $34,000 a year is allowed to contribute as much as 10 percent of each paycheck over six months to buy stock at a 15 percent discount at the end of that period. She can only afford to set aside 5 percent of her pay -- or $1,700 -- and elects to use a Carver Edison loan for the rest.

The manufacturing company’s stock price was $100 on the first day of the six-month period and $140 on the final day. The 15 percent discount is applied to the lower of the two. So on the final day, the worker’s $1,700 in deferrals plus an equal-size loan from Carver will be enough to purchase 40 shares for $85 apiece. That’s an instant 65 percent gain.

Carver will then immediately sell enough of those shares to cover the loan. In cases when the stock price increase over the six-month period exceeds a certain threshold -- say 25 percent, or $125 in the example above -- Carver will collect and sell a few extra shares. Some of those may be sold in the open market, while others will be sold to banks via options, allowing Carver to generate revenue by collecting a small fee on each contract.

In the end, the worker ends up with about 26.4 shares, worth about $3700. Had she elected to forgo the loan, she would’ve been stuck with 20 shares worth $2800. Because the shares are bought at a discount, Shapiro's firm has a cushion in case of a sudden drop in the stock. To protect itself, Carver sells the shares within seconds of their being delivered and assumes the balance sheet risk if the stock crashes. This provides an instant cushion, assuming drops aren't too precipitous.

The model seems like a no brainer, but it may be difficult to get people to understand and buy into the concept. Rosen concluded: "Whether this specific idea will be the one that gets past these barriers, I don’t know." 

But Shapiro has faith. The company has seen “a handful of early adopters in late 2019,” according to the founder, and he predicts that the company will see “a wave of quick followers” going forward. And hey, why not? Borrowing: it's the American way.