Will your compensation plan survive your IPO?
Every year, hundreds of companies of all sizes go public around the world. Despite the pandemic, the year 2020 saw 1,363 initial public offerings (IPOs), nearly a quarter of which were in the tech sector, with IPOs in industrial and healthcare sectors following close behind. In its 2020 IPO report, EY reports that global trades totalled $268 billion, $98 billion of which originated in the Americas. With abundant liquidity and optimism fueling financial markets, the prognosis looks favourable for a resurgence of IPOs worldwide. In Quebec, many companies could try their luck in the coming months, particularly those in the tech, life sciences, natural resources and mining sectors.
Whether you want to access new liquidity, raise your company’s profile, attract new talent or begin a series of mergers/acquisitions, there are many advantages to having your company listed on the stock exchange.
Have you decided to take the plunge? Are you banking on your financial ratios to attract investors? Do you have the liquidity needed to pursue your business strategy? Before you dive in, you may want to take a moment to consider the human factor.
People are the backbone of great companies
For the vast majority of institutional investors, the quality of a company’s leadership is the most important non-financial factor they consider when assessing a new offer. Investors have high expectations of leadership teams, and they especially want to know that a company’s leadership team has the motivation and skills to generate short‑term and long-term gains for shareholders. With this in mind, you may find it appropriate to reconsider your existing compensation plan or put together incentive plans aligned with the new governance model to maximize gains.
When it comes to compensation, there’s no one-size-fits-all solution. But as a general rule, your compensation plan should be:
- Well positioned in relation to your benchmarked market data
- Calibrated to maximize company profits and promote leadership retention, while aligning with your company’s culture, business strategy and maturity level
- Easy to understand and explain
In the context of an initial public offering (IPO), your compensation plan should also protect you against the risks of excessive dilution. In addition, since an IPO will allow shareholders and option holders to eventually monetize a portion of their investment, your challenge will be to demonstrate to investors how you intend to retain and engage the leadership team on which they will rely.
Here is an overview of the three key steps that will help you put the right compensation plan in place for a successful IPO.
Benchmarking: Identifying the right comparator group
Once you have a clear picture of your company’s current state and chosen strategy, the first step is benchmarking.
|Industry||Board of directors||Fees paid to outside directors (board of directors)|
|Size (revenue, number of employees)||Executive committee||Base salary|
|Equity capitalization||Managers||Short-term incentives (bonuses)|
|Region||Employees with key expertise||Long-term incentive plan (LTIP)|
|Ownership structure||Retirement plan and premiums|
The success of this quantitative and qualitative analysis is dependent on the relevance of the comparator group and the credibility of your data sources. The sample you use must be representative of the labour market.
The goal here is not to mirror the market, but to position your company in the market by determining the right compensation mix and the right weighting for each component based on your goals.
Designing a compensation plan: Striking the right balance
The second step is to design a compensation structure that makes sense—one that will generate value for your shareholders and reward your leadership for achieving your business objectives. Ideally, it will also give you enough latitude to make adjustments in future years.
To earn the confidence of shareholders and proxy advisors, a good compensation plan should include:
- A clear definition of the philosophy used for benchmarking
- A proper balance between components of the compensation mix (base salary, short-term and long-term incentives) that takes into account the company’s maturity level (for example, a start‑up will often have more modest salaries and no annual bonus, but long-term incentive plan that offers greater benefits)
- Annual bonus criteria
- The right balance between retention and payments
- The criteria for determining post-IPO LTIP awards, taking into account:
- Retention and internal equity goals
- The value of the remaining non-vested options and their vesting schedule
- The nominal value of the awards
- The expected value of options (Black-Scholes)
- The potential for shareholder dilution due to the LTIP
- Mechanisms for effectively managing the risks associated with incentive compensation:
- Retention risk (after the lock-up period)
- Risk of imbalance (rewarding the same results several times)
- Risk of dilution and too much potential control
- Economic risk (payment scales, stress tests)
- Risk of fraud or abuse (recovery policy)
After the IPO, you might consider adding an employee stock purchase plan to boost staff morale and allow all employees to share in the company’s success.
Communication and disclosure: Getting used to transparency requirements
Going public requires a significant shift in your internal and external communication strategies. Employees of private companies may have a rather abstract idea of how stocks and options work, what they’re worth, and what restrictions apply (lock-up period, trading limits, insider trading, etc.). One of the most important things you can do to ensure a successful IPO will be to explain, in plain language, the value of new compensation plans and how they work.
After your IPO, your company will be an open book, and your entire workforce will have to adapt to this new reality. You will have to produce a prospectus and external reports and disclose some information that you previously considered confidential. Your compensation plans will be under public scrutiny. It will be more important than ever to maintain high standards and develop a thorough understanding of proxy advisory firm guidelines (from ISS, Glass Lewis, etc.) and expectations of shareholder advocacy groups like MÉDAC and CCGG.
Not only will you have to get used to this transparency, but you will also have to ensure consistency over time, since the company will have to live with what it has published from one year to the next.
Takeaways: Dos and don’ts
The IPO process itself is just one of the critical steps in the complex transition from private to public company, the success of which depends on a structured and well-managed transformation of the organization’s processes and culture.
While retaining key leadership members has always been essential to the sustainability and growth of a company, it is now just as vital for earning and maintaining investor confidence. In this context, a solid compensation plan that is aligned with the business strategy sends a clear message and is a powerful lever for encouraging the behaviours you’d like to see.
Surround yourself with experts who will help you navigate this new ecosystem and work with you to determine the compensation plan that best suits your needs and maximizes both flexibility and return on your invested compensation dollars.
That way, you can guarantee that the executive team that rang the bell in celebration of this important milestone will be motivated to continue the journey with you for many years to come.
Considering an initial public offering?
PCI Compensation Consulting is one of the largest independent consulting firms specialized in governance and dedicated to total compensation in Canada. For 20 years, we have been helping companies of all sizes and in all sectors by designing compensation programs that reflect their entrepreneurial nature while respecting modern and sound governance standards.
Bridgit Courey, CPA, CA, C.Dir., Partner
Dominic Girard, Partner