Introduction

With the increase of special purpose acquisition company (SPAC) and traditional initial public offering (IPO) activity in 2021, it seems a private company not yet contemplating a public offering is a rarity these days. In fact, Renaissance Capital reports 397 US IPOs of greater than $50M market cap in 2021 after 221 in 2020 and 162 in 2019. [1]

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 6 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 (i.e., paying for performance) will remain; however, there are several key compensation program features and governance-related practices to consider when making the transition.

This Viewpoint discusses four compensation program areas of focus for management and the Board of Directors when an IPO becomes imminent:

1. Establishing/Updating a Compensation Philosophy
2. Reviewing/Aligning Executive Pay Levels to Business Objectives and Competitive Practice
3. Developing a Long-term Incentive (LTI) / Equity Program Strategy
4. Reviewing/Establishing Severance and Change in Control Policies

We review each of these four areas below via a series of questions companies can ask of themselves as they begin planning an IPO.

Other critical elements to be reviewed and established prior to an IPO include a board of directors’ compensation program, public company governance processes such as the Compensation Committee charter/calendar, Securities and Exchange Commission (SEC) disclosure requirements, and a new regime of preferred practices from external constituents including proxy advisors. We intend to cover each of these topics in subsequent Viewpoint articles.

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 including the purpose of each component, a statement on desired competitive positioning and external market comparators, and a set of guiding principles reflecting company values and actions.

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 a chance to revisit pay levels to better align with short- and long-term business and talent priorities as well as to ensure appropriate compensation for any expansion of position responsibilities. For example, responsibilities for certain positions within the Finance and Legal functions, to name a few, can increase upon the IPO due to additional reporting requirements and may warrant higher compensation levels.

3. LTI / Equity Program Strategy

The primary executive pay change for companies transitioning from private to public status is the shift in approach to equity awards. While there are several differences between private and public equity practices (see Figure to the right), a key difference is award timing:

• The prevailing equity strategy for private companies is event-based awards (i.e., larger/multi-year awards made at hire, promotion, major company milestone / dilutive event) with a focus on targeted aggregate ownership.
• For public companies, the prevailing strategy is annual equity grants with a focus on delivering a targeted grant date dollar value or, in some industries, a vesting dollar value.

It follows then that the most important compensation considerations in going public is determining the go-forward 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 and cannot be overlooked. Plan designs and mechanics can take many forms depending on industry- and company-specific factors. The governing 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.

In addition to adopting an LTI plan to promote employee ownership and align with market competitive award designs, a company may want to consider adopting an Employee Stock Purchase Plan (ESPP), which is the right to allow employees to purchase stock at a discount.

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 to market competitive practices, such policies can also be used to attract and retain key executive talent.

Conclusion

The IPO journey can range from 6 months to as long as 2 years or even longer and it is never too early to start planning. The timeline below summarizes the key considerations and timing for companies that are considering an IPO.

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 (e.g., establish objectives, review relevant information, discuss directional considerations, make preliminary decisions, and adopt final changes when full information is available) 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 transitiion to public company status.

General questions about this Viewpoint can be directed to Brian Lane at (brian.lane@paygovernance.com), Joe Mallin (joe.mallin@paygovernance.com), or Tara Tays (tara.tays@paygovernance.com).

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[1] “U.S. IPO Market.” Renaissance Capital. January 7, 2022. https://www.renaissancecapital.com/IPO-Center/Stats.