Companies transitioning from private to public status typically face the pivotal task of transforming executive compensation structures. This shift is not merely a procedural change but a strategic maneuver to align with public company market norms. The overarching goal is to retain and motivate the leadership team that possesses deep institutional knowledge of the company. Such a strategy ensures that once public, the company continues to drive shareholder value creation for its new, broader shareholder base. Below is a sequential step by step outline that boards and management should consider. While this outline is not all encompassing, these essential steps will help a compensation committee and management effectively navigate the many new factors of executive compensation as a public company.
Develop a Planning and Decision-Making Calendar
For the management and compensation committees, the first step is to develop a detailed calendar. This timeline serves as a roadmap for planning and decision-making. It should outline key milestones such as finalizing the compensation philosophy, benchmarking against peer groups, structuring long-term incentives, and preparing for public disclosures. This calendar not only ensures timely execution of tasks but also aligns the compensation strategy with the broader timeline of the IPO process.
Establish Your Company’s Executive Compensation Philosophy
A well-defined compensation philosophy is the cornerstone of effective executive compensation planning. This philosophy should reflect the company’s values, business objectives, and cultural ethos. It guides decisions on pay mix, performance metrics, and the balance between short-term and long-term incentives. Importantly, this philosophy must resonate with the expectations of the public market investors, ensuring that it is not only competitive but also sustainable and transparent. While each company is different in how they construct their compensation philosophy, recent analysis we have conducted indicates that companies that have a compensation philosophy and target incentive compensation above the market 50th percentile are 50% more likely to outperform their peers.
Define New Competitive Markets for Talents
Transitioning to a public company necessitates redefining the competitive landscape for talent. This involves establishing a peer group of similar public companies against which to benchmark compensation packages. The selection of these peers should consider industry, size, complexity, and geographic presence. Additionally, sourcing appropriate survey data becomes critical to understand current market trends and compensation levels. This data will inform decisions on base salary, bonuses, and equity-based compensation, ensuring competitiveness in a dynamic talent market.
Establish a Competitive Total Rewards Program
The total rewards program encompasses all aspects of compensation – base salary, bonuses, and long-term incentives.
- Base Salary: This should be competitive yet reflective of the company’s stage and financial position. It acts as a stable income source, providing a degree of financial security to the executives.
- Short-Term Incentives: Short-term incentives, commonly referred to as annual cash bonuses, should be structured to drive performance that aligns with the company’s short-term goals. The metrics for bonuses need to be clear, achievable, and directly tied to business outcomes. This ensures that executives are focused on deliverables that contribute to the company’s growth and stability.
- Long-Term Incentives: These are crucial for aligning the interests of executives with those of the shareholders. Stock options, restricted stock units, and other equity-based incentives serve as powerful tools for fostering a long-term commitment to the company’s success. The design of these incentives should consider the potential for value creation post-IPO and the associated vesting periods.
What to do Pre-IPO for Execs and Broader Teams
While in the pre-IPO phase, it’s essential to establish a framework for executive compensation that addresses both immediate and future needs. This might include granting special pre-IPO equity awards to recognize past contributions and to retain key talent through the IPO event. These awards should be structured to vest over a period of time to enhance long-term retention of key executives. Additionally, it’s important to communicate clearly with the executive team and broader employees about the changes in compensation structure and the reasons behind these changes. Transparency in this phase helps in managing expectations and reducing uncertainties associated with the IPO transition.
Consideration of Pre-IPO Ownership
When structuring long-term incentives (LTI) to survive the IPO process and reward/retain key talent, companies often face scenarios where executives and employees have a variety of ownership levels. These varying levels of equity interests can create dynamic challenges when determining future LTI awards. Companies should be careful to ensure that historical awards that may experience a large run up in value but vest upon IPO don’t constitute built-in retention. Rather, companies should evaluate the relationship between employee unvested equity levels and competitive market LTI opportunities to assess how best to approach go-forward LTI opportunities.
Actions at IPO for Execs and Broader Teams
At the IPO, executive compensation often undergoes significant revision to align with public market standards. This may involve converting pre-IPO equity interests (e.g.: profits interests) into a form that is more standard for public companies, such as stock options, restricted stock units (RSUs) and/or performance shares. Additionally, it’s common to implement new performance metrics that are more in line with shareholder expectations and market benchmarks. For the broader team, the IPO often triggers vesting of equity or the opportunity to participate in new equity plans. This is a crucial moment to reinforce the alignment between employee interests and shareholder value.
Establishing Annual Grants Going Forward
Post-IPO, the focus shifts to annual grants as a part of ongoing compensation. The structure of these grants—whether in stock options, RSUs, or other forms—should tie to a company’s go-forward strategy and shareholder experience. Each of these elements provide great bases for the development of appropriate performance metrics that may be required for future awards to vest. The quantum of these grants needs careful calibration to ensure competitiveness without excessive dilution of equity. Additionally, developing a plan for annual equity spending helps in maintaining transparency and consistency in compensation across the company. This includes setting guidelines for employment agreements and severance provisions.
Determine the Board Compensation Program
Board member compensation in a public company context differs significantly from a private company setting. The compensation mix for board members usually includes a combination of cash and equity, with the latter aligning their interests with those of the shareholders. The structure should be guided by industry norms, the company’s size, and its strategic priorities. It’s also crucial to periodically review and adjust this compensation to remain competitive and fair.
Other Compensation-Related Good Governance Items
- Stock Ownership Guidelines: Establish guidelines for minimum stock ownership for executives and board members, reinforcing their alignment with long-term shareholder interests.
- Clawback Policy: Implement a policy to recover incentive compensation in case of financial restatements or misconduct. This ensures accountability and aligns with governance best practices.
- Familiarizing with Compensation-Related Public Disclosures: Executives must understand the requirements and implications of public disclosures like Compensation Discussion and Analysis (CD&A) and Pay Versus Performance disclosures.
- Understanding Role and Policies of Proxy Advisory Firms: These firms influence shareholder voting on executive compensation matters. Understanding their policies and criteria is essential for structuring acceptable compensation packages.
The transition from a private to a public company demands a comprehensive reevaluation of executive compensation. This process is not just about aligning pay with market norms but also about reinforcing a culture of performance, accountability, and long-term value creation. As companies embark on this transformative journey, the principles laid out in this article can serve as a guide to navigate the complex landscape of executive compensation in the IPO context.
