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From private to public – IPO executive compensation checklist

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من الشركات الخاصة إلى الشركات المدرجة – الاكتتاب – قائمة مراجعة

Private companies are from Mars and public companies are from Venus.

Okay, we exaggerate, but there’s no doubt that privately held and publicly listed companies run many aspects of their business very differently, including how each handle executive compensation plans.

To get straight to the point, key executives in private companies might be on a relatively modest salary, but this will be supplemented by sometimes extremely generous equity grant packages. Meanwhile, an equivalent executive in a public company may well be on a much higher salary, but would typically stand to make far less in annual equity grants.

This is one of the points that a private company moving towards a public listing needs to identify and act on, both during the transition to becoming a public company and in the years following.

As with so much attached to the journey of going public, preparedness is key. No one will expect a newly listed company to have fully overhauled its executive compensation strategy by day one of its public life; however, a company that has devoted the necessary time and resources to its IPO effort will have those wheels well in motion by the time the bell rings on that first day.

Any company in the pre-IPO period should have a Compensation Committee in place, whose responsibility is to consider how best to modify all relevant executive compensation plans and practices. This process should begin as early as is feasible, but it’s understood that this kind of transition does not happen quickly and will continue into the post-IPO period.


The pre-IPO Executive Compensation Checklist


Three men part of compensation committee should be in full control of the executive compensation strategyThe Compensation Committee should be in the driving seat when it comes to the executive compensation strategy


Compensation Committees effectively draw up a pre-IPO checklist, with the purpose of this being to create a roadmap that will enable a company to transition its executive compensation plans over time.

Among the most common items on such a checklist will be:


1. Compensation Philosophy

A compensation philosophy needs to be established early on, as it will serve as the foundation for most if not all compensation-related decision-making.
Among the points that need to be addressed in forming this philosophy are:

  • Compensation plan objectives
  • Pay mix (base salary, annual incentives, long-term incentives, and additional benefits – with the blend highlighting short-term vs. long-term and also performance vs. retention and/or attraction)
  • Where the company wants to position itself relative to its peer group (more on peer-group below)
  • The type and amount of equity to be used
  • The approach to benefits and prerequisites (what perks are on offer and what boxes must be ticked to become eligible to receive them).

Aside from the fact that it’s good practice to establish a compensation philosophy, it’s also necessary for practical terms, as companies are obliged to disclose their approach to executive compensation practices in the Compensation Discussion & Analysis (CD&A) section of the proxy statement sent out in advance of shareholder meetings when publicly traded.

The compensation philosophy doesn’t go into huge detail, but it must be 100% accurate in how it presents the Compensation Committee’s approach to executive pay.


2. Public Company Peer Group

Creating a public company peer group will allow the Compensation Committee to effectively benchmark your own executive compensation approach as you adjust to life as a publicly listed business.

It is not uncommon for a private company to prepare competitive pay analyses as and when they deem it necessary, whereas for public companies this tends to be put on a more formal footing, with senior executive pay levels typically reviewed on an annual basis. Creating a public company peer group will give you the information you need to adopt this approach for your business as if you are committed to reviewing executive pay every year, then you need to know how peer companies are compensating their key employees.

Generally, one of the keys to creating such a group is to identify companies of similar size, and this can be done by reference to key indicators such as revenues, assets, market cap, and industrial classification. It is also important to review business models, as this will provide further insight on whether a business you are looking at is sufficiently similar as to be regarded as a true peer for these purposes.

Don’t underestimate the time and effort involved in peer-group construction. Poorly constructed peer groups have been linked with compensation levels that are either too small or too generous.


3. Equity Usage

When working towards an IPO exit event, private companies typically set aside 8% to 15% of shares for management. Most of these shares will tend to be granted in a single equity grant, with the rest set aside for future grants to existing management and future key executives.

The 8% to 15% equity allocation is generally taken to be sufficient to ensure attractive total pay for management in the future, assuming cash compensation is set at a competitive level.


4. Executive Compensation – Competitiveness and Design


Three wooden block with carios geometric formats and reads on top

Usually, public and private companies will be very different in what types of equity they grant to their executives


Public and private companies tend to prefer different types of equity grants when looking to reward key employees. For example, private companies prefer performance-vested options, whereas public companies tend to shy away from that type of grant, preferring other equity designs.

This is one of the “public vs private” points that need to be properly teased out by a Compensation Committee. When looking at the design of an executive compensation plan, committee members need to understand that what works for a private company won’t necessarily work for a publicly listed company.

On performance-vested stock options, the issue is two-fold – for the options to gain any value, the stock price must increase and the performance condition must be achieved. For a publicly listed company, this can be tricky, as the employees in question won’t merely be relying on their own performance, they will also be subject to the whims and vagaries of the stock market. For that reason, performance-vested options are not regarded as a preferred choice, as they will not necessarily achieve the desired objective of motivating key employees.

Compensation strategies need to establish a link between effort and reward and, again, what works for a private company will not necessarily translate well into a post-IPO landscape.

With this in mind, the Compensation Committee and management team need to examine the available data on long-term incentive plan prevalence and practices, and based on that design a plan that aligns with public company practices, motivates key employees, and is compatible with shareholder growth objectives.


5. Board Pay

Publicly listed and privately held companies will also differ in terms of their board of directors’ pay practices. Private company board members may or may not be paid, depending on several considerations. Some board members may be employees of major investors, whereas others may be key executives with expertise and experience relative to the role. Individuals in the latter group will always be paid, whereas those in the former category may not.

As alluded to earlier, private and public companies tend to treat cash and equity compensation in reverse. Most often, private companies lean heavily towards equity with relatively modest cash compensation, whereas public companies will pay more in cash compensation, and generally have more limited possibilities in terms of annual equity grants.

This being the case, board pay arrangements need to be reviewed in the pre-IPO period. Practices will need to be brought more into line with how public companies tend to operate, but there is also an onus to make sure that what is on offer to new directors in the future will be attractive.


6. Lock-up periods

A lock-up agreement prevents insiders of a company from selling their shares for a specified period of time (usually around 80 – 180 days) after going public.

Lock-up agreements are not required by law, but underwriters will often require executives, investors, and other company insiders to sign these agreements. The general idea behind them is to prevent too much selling of stock in the period right after going public and driving the price down.

What do you need to know when it comes to executive compensation? Essentially, that they exist and should be part of your strategy, from how you communicate it to your executives to how they will impact the IPO and share price itself.

They have the potential to negatively impact your share price once they expire (because suddenly you have more potential sellers) so some company’s use staggered lock-up periods, although counter-intuitively studies have shown this staggered strategy actually seems to impact the share price more negatively than a single date where the agreement expires.


Overseeing the transition when going public

Private and public companies will differ on many aspects of executive and board compensation. As private companies move through the pre-IPO process, they should consider an audit of all aspects of their pay practices, to identify what needs to change and over what timeframe. These changes can be implemented over an extended period, even beyond going public, which means that Compensation Committees should have ample time to identify what needs to be done and oversee the transition from private to public company practices.

While the road to going public may be a long and arduous one, with many twists and turns, when it comes to executive compensation it’s vital to follow the steps outlined above – if not, you may find yourself on the surface of Mars wondering why Venus looks so different nowadays.

Please Note: This publication contains general information only and Global Shares is not, through this article, issuing any advice, be it legal, financial, tax-related, business-related, professional or other. The Global Shares Academy is not a substitute for professional advice and should not be used as such. Global Shares does not assume any liability for reliance on the information provided herein.

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