What every board and compensation committee should know and do before going public By Brian Lane, Joe Mallin and Tara Tays
With the increase in IPO activity in 2021, it seems a private company not yet contemplating a public offering is a rarity these days. The process of transitioning from a private to a public company takes significant effort across essentially all of a company’s core functional areas over an extended period – often at least six months and, in many cases, closer to a year or longer.
From a talent and compensation program perspective, the core tenet of rewarding executives and employees for driving business results will remain but there are several key compensation program features and governance-related practices to consider when making the transition.
1. Compensation philosophy We regularly encourage our clients to adopt and codify a compensation philosophy. A well-documented compensation philosophy includes the primary objectives of pay programs covering the purpose of each component, a statement on desired competitive positioning and external market comparators.
This extract will provide the key questions to ask when planning for an IPO. To understand Pay Governance's detailed perspective, please refer to the full article from which this extract has been taken.
Objectives: What are our guiding principles and objectives?
Elements: What pay elements will we use to drive business and talent strategies? What is the appropriate pay mix?
Frame of reference: How do we define our competitive market for talent?
Competitive position: What is our targeted level of competitiveness? Should our competitive positioning vary by pay element?
Selection criteria: Which are the key characteristics of our company that should be reflected within our peer group – industry, revenue, market cap, headcount, profitability, geographical footprint, and so on?
Peer group use(s): Should we have more than one peer group (for example, one for understanding competitive pay levels and one for incentive and related governance practices)?
Sample size: How many peer firms are appropriate to provide robust competitive information?
Established public vs recent IPOs: Should our peer group include recent IPOs, established public companies, or a mix?
2. Executive pay considerations With respect to total compensation, the change in ownership structure can have a direct impact on the level of pay required to maintain competitiveness for some positions.
While not always necessary, an IPO provides an opportunity to revisit pay levels to better align with business and talent priorities and ensure appropriate compensation for any expansion of position responsibilities. For example, responsibilities for certain positions within the finance and legal functions can increase with an IPO due to additional reporting requirements and may thus warrant higher compensation levels.
Competitiveness: Are our current cash pay levels representative of competitive public company levels, and do they reflect our go-forward compensation philosophy?
Adjustments: If below market, when is the right time to implement pay adjustments – at IPO or at the first annual merit cycle as a public company? All at once or over time?
New paradigm: Public companies predominantly use an annual grant cycle for making equity grants. Are we prepared to shift our thinking to an annual grant approach based on grant-date dollar value?
Competitiveness: How do we define competitive equity awards as a public company?
3. Equity program strategy The primary executive pay change for companies going public is the shift in approach to equity awards. While there are several differences between private and public equity practices, a key difference is award timing:
The most important compensation consideration in going public, therefore, is determining the long-term incentive (LTI) strategy. LTI awards represent a key component in attracting/retaining talent and are usually a significant component of overall compensation. During the IPO-readiness phase, LTI plan design and allocation of shares for future grants is highly important. Plan designs and mechanics can take many forms depending on industry and company-specific factors. The governing LTI plan documents tend to remain broad and allow for flexibility to change designs and award types over time without needing to amend the LTI plan.
Purpose: Should we reward a select group of employees for their IPO-related contributions or more broadly recognize all employees?
Eligibility: What criteria will be used to determine recipient award size – affordability, employee level, retention risks, and so on?
Award design: Should the IPO award vehicle and design differ materially from the annual LTI award approach?
Objectives: What are the objectives of the LTI program?
Market practice: What types of awards do our competitors use?
Eligibility: What criteria will be used to determine eligibility?
Award design: What vehicle(s), vesting conditions and award terms best align with our business and talent strategies? Should our approach differ by employee level?
Timing: When should the company seek board approval on the go-forward plan document?
Share pool and usage: How many shares should be available for grant? What are appropriate levels of dilution at IPO and post-IPO? Should the plan include an evergreen provision?
Plan provisions: For many of the provisions common within an equity plan document, the key questions are of balance between – flexibility to account for growth and expectations from shareholder groups on shares reserved – what should be included in the governing document and what can be handled via grant agreements – appropriate protections for the company (such as restrictive covenants) vs the award recipients (such as termination coverage)
Key provisions to pay specific attention to include evergreen refresh, share recycling methodology, board of director grant limits, termination provisions (treatment of unvested awards upon termination without cause, voluntary termination, death, disability, and other forms of termination), change in control protection and shareholder approval for option repricing
4. Reviewing severance coverage/termination policies Severance benefits and termination treatment is another area typically discussed before going public. In addition to creating policies to align with market competitive practices, such policies can also be used to attract and retain key executive talent.
Documenting benefits: Should severance provisions be included in employee agreements or as a stand-alone severance policy?
Termination events triggering benefits: What benefits will employees receive upon termination for cause, death, disability or without cause? Should the company’s termination benefits vary by employee level?
Defining non-change-in-control (CIC) benefits: Should a cash benefit be defined as salary only or salary plus annual incentive? If annual incentive is included, how will it be defined? What multiple will be used to calculate the cash severance and how will the multiple vary among different levels of executives? What will happen to unvested equity? If stock options are granted, what will the exercise period be for vested awards upon the termination event? Will health and welfare benefits continue to be provided?
Defining CIC benefits: Similar questions to the above with the added discussion of whether benefits should be enhanced in any way if qualifying termination occurs post-CIC
Conclusion The IPO journey can range from six months to as long as two years or more and it is never too early to start planning. Compensation programs are one part of the overall IPO process.
Early planning, reliable and experienced partners and a commitment to making decisions in an efficient, effective and timely manner can help the process run smoothly. Thoughtful and early planning can take the stress out of what is likely an exciting time for employees, management, investors and directors and support the all-important transition to public company status.
Pay Governance is an independent firm that serves as a trusted adviser on executive compensation matters to board and compensation committees. Our work helps to ensure that our clients’ executive rewards programs are strongly aligned with performance and supportive of appropriate corporate governance practices. We work with more than 400 companies annually and have a team of nearly 70 professionals throughout the US with affiliates in Europe and Asia with experience in a wide array of industries, company life cycles and special situations.
Contact us Brian Lane: brian.lane@paygovernance.com Joe Mallin: joe.mallin@paygovernance.com Tara Tays: tara.tays@paygovernance.com
