Australia’s initial public offering (IPO) market is still very active, particularly across technology, fintech and natural resources companies. As companies prepare for their IPO, board directors’ focus is on the financial, regulatory and disclosure issues to manage risk for the post IPO life. What is often overlooked, at least until late in the piece, are executive remuneration and governance frameworks.
Potential investors consider the remuneration and governance framework as one of several critical risk and success factors. For example, they ask:
- To what extent is there an experienced and professional management team in place to meet prospectus forecasts?
- To what extent is that management team locked in, especially past the ESCROW period?
- How aligned are they with investor interests?
- How does their reward structure support the business plan?
- Are there any aspects of the pay framework that are warning signs that not all is right in terms of governance?
To assist, Guerdon Associates have provided a checklist for directors engaged in an IPO process to assist in establishing a sound and robust remuneration and governance framework.
1. It is probable that you will need to lock in new incentive structures
Venture-backed companies typically focus on orders and revenue for incentive 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 equity of a pre-IPO company with no liquidity. These issues almost always prompt a relook at executive short- and long-term incentive plans as part of the IPO.
Incentive frameworks need to be designed around the company’s immediate and near-term objectives, meet investor expectations and ensure that management is retained and motivated beyond the escrow period.
2. Expect to be paying more cash
Venture-backed executives will often be paid less than the market in fixed remuneration and annual incentive (STI/bonus), since cash is scarce and the focus is on the main prize, the IPO. These companies use equity to conserve cash, provide executives with “skin in the game”, and provide alignment. At this point management’s equity plan (MEP) will crystallise.
Expectations change post-IPO. Much of the big gains in equity value will have been earned on 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. One of the more difficult tasks for new boards is considering how to get executives’ pay to market levels under the greater investor and proxy adviser focus in the first two years of listed life.
As a result, companies, before they get to the IPO, conduct a market pay analysis and take steps to correct market inequities. This market review would provide an excellent platform for discussing and establishing a pay positioning strategy post-IPO.
3. Fix internal inequities before the IPO
Pre-IPO companies often have extensive internal equity problems. Late hires to professionalise the management ranks prior to the IPO are often paid higher in cash than the early recruits who have more in company shares.
Companies should assess the internal relativities in terms of ownership and cash pay before the IPO. It is easier to at least partially even up internal inequities 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.
4. It is difficult 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. The company cannot afford to put all executives on equal footing in this regard.
5. Plan for declining use of equity unless you will maintain the growth.
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. But, this is a generalized statement. It would not hold true for technology companies with significant growth potential. These companies tend to list in Australia much earlier than counterparts in the US, Canada and the UK in order to source capital for growth. Hence, they will remain cash poor post IPO as they seek more growth.
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, often, a mess. Getting used to introducing more governance and structure (i.e., setting pay ranges, target and maximum incentive opportunities as a percentage of fixed remuneration or profit share structure, and equity grant opportunities) is one of the keys to scaling the business. If there is no structure, then everything is an ad hoc negotiation that 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 who is best suited and will succeed in the 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 serious about governance
New IPO companies can get caught flat-footed if they are not prepared for the new listed company governance environment. An early wrong step can take a long time to get over in a post IPO environment. There are more stakeholders. They have long memories.
Matters to consider include:
- Minimum shareholding policy for executives and directors
- The remuneration committee calendar for the year
- Equity grant processes for existing and new executives
- Remuneration report disclosures and preparation
- Notice of meeting disclosures for equity grants