Pay Governance reviewed 368 initial public offerings (IPOs) in 2021 to understand equity program practices which included: dilution at IPO, new share pools, evergreen provisions, and overhang levels.
Companies typically enter into an IPO with pre-IPO equity awards to management/employees representing approximately 5.4% of shares outstanding (commonly referred to as dilution).
Virtually all companies request additional shares for a new equity plan prior to or at IPO, with the typical new share request representing 8.2% of fully-diluted shares outstanding.
Within these new equity programs, the vast majority of IPOs in 2021 (73% across all IPOs as well as 85% and 90% among Biotech/Pharma and Tech IPOs, respectively) included an automatic annual refresh provision (i.e., an evergreen).
Our analysis found considerable differences by industry, with certain industries — namely, Bio-Tech/Pharma, Health Care Equipment/Services and Tech — leading others in terms of equity dilution and overhang.
- For example, Tech companies had the highest overhang (17.2%) and Financial Services had the lowest overhang (8.8%) at IPO, with median overhang for all 368 companies at 14.4%.
Conversely, our research showed that market capitalization appears not to be a significant factor in differentiating equity award pools although Boards typically factor in relative size when making equity pool decisions.
The initial public offering (IPO) market has seen unprecedented activity in 2021. According to Nasdaq’s IPO Calendar database, there were 1,043 U.S. public offerings between January 1, 2021 and December 31, 2021 (includes micro and small caps), with 289 of these offerings listed on the New York Stock Exchange, 754 listed on Nasdaq Exchange, and total equity raised just shy of $334 billion. By comparison, in all of 2020, listings on these exchanges raised $158 billion (less than half of 2021’s aggregate value). While there has been a 119% increase in the number of companies that went public in 2021, there are likely many others that started their public offering journey with expectations for a potential 2022 IPO (though we predict that 2022 IPO activity will likely be lower than 2021 given current macroeconomic and geopolitical uncertainties). If an IPO is on the horizon, we believe early planning for compensation program decisions can help smooth the intensive transition process. See Pay Governance’s Viewpoint: IPO Readiness: What Every Board and Compensation Committee Should Know and Do Before Going Public for an overview of the key compensation related areas for management and board members to consider.
Several key terms are referenced throughout this Viewpoint — see below for specific definitions.
One of the most important areas of focus for companies facing the transition from private to public company status is their equity compensation program strategy. The current red-hot talent market heightens the need for flexibility to grant equity awards to attract, motivate, and retain talent while acknowledging public company norms and governance environment.
When developing a public company equity strategy and establishing a new equity plan, including the initial reserve and other features, companies must balance several external and internal considerations. External factors include prevailing governance norms as well as competitive data from similarly situated recent IPO companies or industry peers, and internal factors include projected equity needs, headcount growth expectations, desired compensation philosophy with respect to cash vs. equity, and managing dilution and share usage levels.
To better understand some of these external factors and prevailing practices among recent IPOs, Pay Governance researched 386 public offerings from January 1, 2021 through December 31, 2021. More specifically, we examined key aspects of these companies’ equity plans, including new shares reserved for issuance, equity dilution and overhang at the time of IPO, and the prevalence of automatic share refresh (i.e., evergreen) provisions. Further, we analyzed the data for notable differences based on market capitalization and industry. A follow-up Viewpoint will address equity granting practices, including the issuance of equity award grants leading up to or at IPO and the types of awards granted.
In addressing key equity program considerations, one approach we encourage includes the following steps:
- Understand current outstanding equity and expected level of dilution at IPO.
- Review remaining shares available for grant in existing equity plan(s) and understand/decide whether the shares are cancelled or rolled over into a new equity plan. Our research found the amount of available shares is typically relatively low at the time of IPO, but this varies widely by company.
- Project expected equity needs for the first several years as a public company to establish the required new share reserve and evergreen provision.
- Compare aggregate equity pool requirement and resulting total overhang to competitive information for reasonableness.
Summary of Key Findings
Our research revealed several interesting findings which are summarized below:
Conclusion: Balancing the internal and external perspectives
Strong IPO activity in 2021 provides companies considering a 2022 IPO with a road map for developing an equity plan, including dilution levels, the size of new share requests, and overhang at IPO, as well as the use of evergreen provisions. To achieve an appropriate balance of internal needs with external expectations, companies should first prepare a detailed multi-year projection of future equity awards based on previously authorized shares, the value of equity grants by level in the organization, current and projected headcount, analysis on the range of future stock prices, and the types of equity award vehicles that may be used (i.e., potential mix of stock options and full value shares such as restricted stock units and performance shares). Once a baseline level or range of future equity needs is established, companies should compare it to the 2021 IPO data discussed above — which varies by industry and, to a lesser extent, market capitalization — to evaluate if share needs are in line with market expectations and the company-specific conditions that require more or fewer shares.
General questions about this Viewpoint can be directed to Mike Kesner (firstname.lastname@example.org), Brian Lane (email@example.com), or Tara Tays (firstname.lastname@example.org).