Aaron Shapiro's firm cleared a regulatory hurdle in December, when the IRS determined that companies can let employees benefit from Carver Edison's loans without jeopardizing the tax-exempt status of their ESPPs. (Photo: Bloomberg)

(Bloomberg) –Aaron Shapiro's quest to rethink employee stock purchase plans began with a startling insight: If only his mother had participated in one, she'd be a millionaire today.

A few years ago, she asked her son for financial advice and mentioned her employer's ESPP, which she didn't understand. So Shapiro, 26, who got his finance degree from Babson College, dug into the prospectus.

The employer, UnitedHealth Group Inc., allows workers to buy shares twice a year at a 15 percent discount. There's no minimum holding period, meaning participants can sell the shares immediately and pocket the difference.

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

Shares of UnitedHealth have returned almost 4,000 percent in the past two decades, meaning his mother missed out on gains of more than $1 million.

Eureka moment

Shapiro's eureka moment prompted him to found Carver Edison, a fintech startup that provides interest-free loans to workers unable set aside money from their paychecks to buy stock on the cheap.

The firm cleared a major regulatory hurdle in December, when the Internal Revenue Service determined that companies can let employees benefit from Carver's loans without jeopardizing the tax-exempt status of their ESPPs.

Eli Broverman, co-founder of robo-adviser Betterment LLC, led Carver's latest funding round and is a member of its board.

Now Shapiro is seeking to persuade some of the roughly 4,000 U.S. companies that offer ESPPs to millions of workers to use Carver's services and boost participation in the plans.

Carver's business model hinges on a little financial gymnastics that involves capturing a portion of an employee's stock gains above a certain threshold and using that to sell options contracts to banks. In any scenario, Shapiro said, the worker will end up better off with one of Carver's loans than without it.

Among his supporters is human-resources consulting firm Aon Plc, which struck a deal with Carver this year to present the concept to corporate clients.

Proponents of ESPPs hail them as a lucrative workplace perk that fosters a culture of ownership among employees and aligns their interests with those of shareholders.

They're also seen as a tool to help curb growing income inequality in the U.S. While real wages have largely remained stagnant for decades, long-term investments in equities have paid off handsomely, with the S&P 500 generating a total return of about 220 percent over the past 20 years.

Instant disposals

Workers who opt into ESPPs agree to set aside part of every paycheck to buy company shares on preset dates, usually every three or six months.

The shares are bought at a discount of as much as 15 percent to the market price at the start or end of each period, whichever is lower. Some companies require workers to hold the shares for a certain period of time, but most allow instant disposals, according to a survey by Fidelity and Radford, a unit of Aon.

Still, only about one-third of eligible workers actually participate, said Corey Rosen, who founded the nonprofit National Center for Employee Ownership and briefly served on Carver's advisory committee.

“It's nuts,” Rosen said of the low participation rate. “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, like Shapiro's mother, or prefer being paid upfront rather than deferring it for a future benefit.

But the biggest barrier is that many simply can't afford to set aside the money, according to Jon Burg, the practice leader of Aon's equity compensation advisory group.

Two inventors

This group of financially strapped Americans is central to Carver's business model: Offering an opportunity to increase gains by using leverage, but without downside risk.

Shapiro said that concept and the company's name is a nod to two inventors: George Washington Carver, who helped poor farmers improve agricultural output; and Thomas Edison, who shared some of his intellectual property with other scientists for free.

Here's 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.

The idea behind using part of the gains to sell options is “to have the market makers pay the bills for factory-floor workers to have more money in their pockets,” Shapiro said.

Downside protection

In the end, the manufacturing worker will end up with 26.4 shares, worth about $3,700, that are hers to keep or sell.

Had she elected to forgo a Carver loan, she would have been left with 20 shares worth $2,800. (Contributions to ESPP stock purchases aren't tax-deductible, but the example excludes income taxes for simplicity.)

Because the shares are bought at a discount, Carver Edison has a built-in cushion in case of a sudden drop in the stock.

To protect itself against a crash, Carver sells the shares within seconds of their being delivered by the company and it assumes the balance sheet risk should the stock price crash or a trading glitch occurs during that short window.

In theory, Carver's model may seem like a no-brainer. But the firm will still have to figure out how to get people to understand and buy into its concept, which adds another layer of complexity to a topic that many companies already struggle to explain to workers, said NCEO's Rosen.

“Whether this specific idea will be the one that gets past these barriers, I don't know,” he said.

Shareholder dilution

Shapiro said he's convinced it's possible. Carver will provide educational material to clients to boost sign-ups among workers as part of its offering.

Greater participation will also increase shareholder dilution and result in higher compensation costs, which could be a deterrent for some companies, according to Aon's Burg.

Still, the program brings accounting benefits, and “my experience is that most companies with an ESPP want higher participation and believe in the benefits derived from the program,” he said.

Aon has already seen interest among some clients in Carver's offering and expects “a handful of early adopters in late 2019,” he said. As companies grow more familiar with the concept, “we will see a wave of quick followers.

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