28/02/2011
Australia’s IPO market is heating up, and not only in the resources sector. Executive pay frameworks are often overlooked in the IPO process, but are among several critical success factors for potential investor consideration. That is, to what extent is there an experienced and professional management team in place to meet prospectus forecasts? To what extent are they locked in? How aligned are they with investor requirements? How does their reward structure integrate with the business plan? Are there any pay wrinkles that are warning signs that not all is right?
Below we have developed a checklist that may assist boards engaged in an IPO process in establishing an appropriate pay structure.
1. It is probable that you will need to redesign short term and long-term incentives
Venture-backed companies typically focus on orders and revenue for bonus purposes, and private-equity-backed companies tend to focus on the cash generated, i.e. EBITDA. In addition, publicly traded stock post-IPO is a different sort of incentive vehicle than pre-IPO stock with virtually no liquidity. These issues almost always prompt a relook at the short- and long-term incentive plans as part of the IPO.
2. Expect to pay more cash
Venture-backed IPO executives often will be paid less than the market in salary and bonus, since cash was scarce prior to the IPO. Instead, equity was considered a way to conserve cash, provide executives with “skin in the game”, and provide alignment. Expectations change post IPO. Much of the big gains in equity value will have been earned by pre-IPO stock. In addition, once the company is cashed up, executives will be looking to have reduced exposure to uncertain stock and more in cash. They will seek to be paid like other public company executives. As a result companies, before they get to the IPO, should conduct a market pay analysis and take steps to correct irregularities to market. This survey should provide an excellent platform for discussing and establishing a pay positioning strategy post-IPO.
3. Plan for declining use of share-based pay
Use of equity to pay employees is typically higher for pre-IPO than post-IPO companies. IPO companies need to carefully budget their equity usage and manage to a declining usage rate over time.
4. Fix internal inequities before the IPO
Pre IPO companies often have extensive internal remuneration relativity problems. Late hires to professionalise the management ranks prior to the IPO may have higher cash pay than the early recruits who have more in company shares. Companies should assess where everyone is in the pecking order in terms ownership and cash pay before the IPO. It is easier to at least partially even up internal inconsistencies before the IPO happens. More equity may need to be allocated to some. But it should be easier because the valuations are lower and topping up executives is not as costly or visible as after the IPO. Others will need more cash.
5. You are unlikely to fix the “inequities in equity” after the IPO
The “haves” are those who came into the company prior to the IPO, and the “have-nots” are the ones who came in afterwards. Most executives understand that those who were there prior to the IPO took more risk, and therefore, deserve to be rewarded for that risk, and the company can’t possibly afford to put all executives on an equal footing in this regard.
6. Require a more disciplined approach to pay
Pre-IPO companies are typically non-bureaucratic, responsive and flexible. Their pay practices reflect this and are, typically, a mess. Getting used to introducing more structure (i.e., setting salary ranges, target bonus opportunities as a percent of salary, and equity grant ranges) is one of the keys to scaling the business. If there is no structure, then everything is an ad hoc negotiation, which is sure to lead to pay inequities (and discontent).
7. Aggressively manage the make up of the executive team
Not all executives will take to the post-IPO environment like a duck takes to water. Some will drown. It is important to determine which executives will succeed in the public listed company environment. It may sound ruthless to employees who have stuck with you in the difficult early stages, but it is important that assessments of executive ability to manage post IPO be made and actions taken that are consistent with these assessments before the IPO. You want a stable team post IPO.
8. Get very serious about governance
New IPO companies can get caught flat-footed if they are not prepared for the new governance environment. It can take a long time to overcome an early wrong step in a post-IPO environment. There are more stakeholders. They have long memories.
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