Initial Public Offerings

Companies preparing for an initial public offering (IPO) will need to acquaint themselves with the executive compensation requirements associated with being a publicly traded company. Executive compensation expectations change with a broadened investor base, and executive pay decisions become public knowledge through required annual filings. Companies in the process of going public need to file an S-1 registration statement, which includes an overview of executive pay programs. After IPO, proxy advisory firms assess public company pay programs and provide voting recommendations to investors. While privately held companies have tremendous latitude over executive pay programs and decisions, publicly traded companies strive to not stand out among peers.

Preparing Pay Programs for IPO

Preparing executive pay programs for an IPO is a process that ideally should start a year before the event. Below are the various activities that should be performed in anticipation of an IPO:

Determine Compensation Philosophy and Peer Group

One of the first items for the compensation committee is to work with management to define the company’s pay philosophy and identify a peer group of comparable companies used for compensation benchmarking. The pay philosophy should address the compensation program’s guiding principles, the pay components and mix, the market for talent, and how pay is positioned relative to market, including variation by pay component. The peer group should include public companies with similar characteristics to the company going public, including industry, revenue, market capitalization, number of employees, geography, and/or business economics. Another consideration is whether the peer group should include companies that recently went public.

Review Pay Levels and Incentive Practices

Being an executive of a publicly traded company can mean changes in responsibilities. As a result, pay levels should be assessed prior to IPO. In addition, executives at public companies have a significant “at-risk” portion of compensation tied to incentives and company performance, so incentive opportunities and the pay mix for executives may need to be adjusted. In general, annual incentive plans often become more structured and focused on company performance and use less discretion.

With respect to long-term incentives, equity grants are usually made before or in conjunction with the IPO. The company should assess executives’ outstanding equity awards before IPO to understand the potential value after the transaction, the portion of the awards that remain unvested, and any executive retention risks.

Some companies choose to make founders or retention equity grants prior to or in conjunction with the IPO. Founders grants can be made to select executives or more widely; such grants promote retention and celebrate an important company milestone. Following IPO, companies typically change their approach to granting long-term incentives, so the committee and management should prepare for post-IPO equity grants.

Pre- and Post-IPO Equity Practices
	Pre-IPO	Post-IPO
Grant Timing	Event-based or periodic	Annual
Vehicle	Stock options, stock appreciation rights or profit interests	Mix of time-based vehicles, such as restricted stock, and performance-based long-term incentives
Opportunity	Denominated as a % of common shares	Denominated as a target dollar value
Vesting	4 or more years	3 or 4 years with variation by industry
Other		Stock ownership guidelines are common

After IPO, the committee also will need to conduct yearly risk assessments of both annual and long-term incentive programs to ensure that incentives are not encouraging excessive or inappropriate risks.

Draft Long-Term Incentive Plan and Consider an Employee Stock Purchase Plan (ESPP)

Prior to the public offering, the committee will need to work with management and legal counsel to draft the equity incentive plan for the newly public company. This process usually includes requesting additional shares for the plan in conjunction with the IPO, and, increasingly, an annual “evergreen” replenishment to the share reserve. An IPO is also the appropriate time for companies to consider implementing an Employee Stock Purchase Plan. ESPPs, often designed as tax-qualified plans under IRC Section 423, are an attractive benefit to employees, as such plans allow them to purchase company stock – often at a discount – through payroll deductions.

Review Current Employment Contracts and Practices

The company should review and audit current executive employment agreements, pay practices, and change-in-control and severance policies to ensure that there are no “poor” or egregious pay practices, such as executive loans, tax-gross-ups, single trigger change-in-control severance, excessive perks, etc. Any issues found can be corrected to conform to public company practices ahead of the IPO.

Revise the Board of Director Pay Program

Serving on a public company board involves more risk than private company board service. Given the increase in risk, the amount of director compensation increases, and the pay mix changes to be more heavily weighted toward equity instead of cash. The structure of the pay package is designed to achieve alignment with shareholder objectives, and typically involves stock ownership guidelines similar to those established for executives