While companies should always ensure that their executive compensation programs are aligned with their market for talent, the time leading up to and after an initial public offering (“IPO”) can often be a significant challenge for companies trying to determine what is and isn’t market-based compensation. Public company compensation disclosures often reflect compensation programs for more mature, stable-state companies that do not have some of the same constraints that private companies have. However, these complexities do not make having effective compensation programs any less critical if these companies want to attract, retain and drive the performance of executives at this key juncture in a company’s life cycle.
To help better understand the compensation pay practices among recently IPO’d companies (including base salary, short-term incentive (“STI”) and long-term incentive (“LTI”) compensation), Alvarez & Marsal’s (“A&M’s”) Compensation and Benefits practice examined the Compensation Discussion and Analysis (“CD&A”) portion of Form S-1 filings of the companies that went public over the past two-plus years. A copy of the survey can be downloaded here.
- While base salary is an important component of pay, incentive compensation is a particularly integral part of the total compensation package for executives at recently IPO’d companies. On average, incentive compensation — including annual (e.g., STI) and LTI — comprises approximately 79 percent of a CEO’s and 73 percent of a CFO’s total compensation package.
- Despite this emphasis on incentive compensation, STI designs remain predominantly discretionary, at least in part, especially compared to the more objective and formulaic structures utilized by more mature public companies. Only 14 percent of the recently IPO’d companies utilized STI plans where the payout is determined on a purely formulaic basis with no Board discretion, while approximately 86 percent of companies utilize a program that is at least in part discretionary.
- Similarly, LTI award structures at recently IPO’d companies are primarily time-based with vesting following completion of a service period, as opposed to performance-based awards that only vest if company performance surpasses pre-established thresholds. Time-based appreciation-only awards (i.e., options and stock appreciation rights) were utilized by approximately 83 percent of the recently IPO’d companies and time-based full-value awards (i.e., restricted stock/units, phantom units, etc.) were utilized by 30 percent of the recently IPO’d companies, while only approximately 22 percent of the companies used performance-based awards in their LTI structures.
- The emphasis on discretionary and time-based incentive awards is not particularly surprising given the difficulty newly-IPO’d companies have in forecasting performance in their initial public years. As a result, where pre-IPO companies did utilize performance criteria for their incentive awards, there was a significant emphasis on “milestone” metrics (i.e., awards that vest upon the completion of an event, such as the IPO), as opposed to more traditional performance metrics that are more prevalent among in the broader market (such as numerical financial or operational goals). Approximately 23 percent of pre-IPO companies utilized milestone metrics in their STI award designs, and approximately 35 percent utilized these types of metrics in their LTI structures.
- In addition to determining amounts, mix, and design of executive pay, a particularly acute challenge faced by IPO’ing companies is how much equity to allocate for current and future awards. Oftentimes, the pre-IPO share authorization reflects the last time the company will be able to set the plan size and design parameters before having to heed input from institutional shareholders and proxy advisory firms. As such, the pre-IPO share pool is often intended to last as long as possible so that companies can maintain plan design flexibility for an extended period before having to go back to shareholders to authorize additional shares. The average pre-IPO equity share pool authorization as a percent of total shares outstanding was approximately 12.6 percent, and the median share pool size was approximately 10 percent of total shares outstanding.
Alvarez & Marsal Taxand Says
Preparing for an IPO involves many different facets of an organization’s business including legal, regulatory, financial, and operational considerations. Public companies face additional regulations and greater disclosure requirements than private companies, particularly regarding the transparency of a company’s executive compensation programs. Because of the additional requirements, executive compensation has become a relatively complex aspect of preparing for an IPO. By forming an IPO roadmap, however, a company can ensure that its executive compensation programs and policies are competitive with the market, aligned with industry norms, adequately sized for future needs (i.e., share pool allocations), compliant with various governance requirements and best practices, and designed to align executive and shareholder interests.
A Note About SPACs
A special purpose acquisition company, or SPAC, is a publicly-traded company that was formed for the sole purpose of acquiring or merging with a private company, taking them public in the process. The requirements of going public through a merger with a SPAC are typically less burdensome than a traditional IPO, which is one of the reasons SPACs have exploded in popularity over the past several years. Generally, the SPAC has no business operations prior to the acquisition, and as a result SPACs rarely pay any executive compensation prior to the transaction. As a result, only SPACs that have completed a transaction were included as part of this analysis. As a follow-up to this survey, we will be conducting an analysis of compensation practices among SPACs following the transaction.