Why Is Post Ipo Equity Higher Than Pre Ipo

Why is post ipo equity higher than pre ipo

January 25, 2011

Executive Compensation: Before and After the IPO

This article originally appeared on Robin A. Ferracone’s “Executive Pay Watch” blog on Forbes.com.

It’s unmistakable that the IPO market is heating up.

How an Initial Public Offering (IPO) Is Priced

According to IPO Monitor, the number of IPOs increased in 2010, up threefold from 2009, and there’s no slowing in sight.

I recently attended a board meeting for a company that just IPOed. The Compensation Committee was having its first post-IPO meeting, and not surprisingly, had more questions than answers.

These questions ranged from compensation strategy and design to the nuts and bolts of good governance processes.

Having assisted a number of companies through IPOs, I’ve learned some lessons about what challenges companies face when transitioning through IPOs and what are the most successful strategies in dealing with these challenges. Here’s my “top ten” list of what I’ve seen works best:

10. Cash compensation will become more important in the pay mix – Venture-backed IPO executives often will be paid less than the market in salary and bonus, since cash was scarce prior the IPO and equity was counted on to “carry the day.”  As a result, companies, ideally before they get to the IPO, should conduct a competitive pay analysis and take steps to correct inequities.

This competitive look also provides an excellent platform for discussing and establishing a pay positioning strategy post-IPO.

9.

Pre-IPO startup compensation

Go ahead – fix internal inequities before the IPO – Companies should assess where everyone is in the pecking order in terms of ownership and equity position before the IPO. It’s easier to at least partially even up internal inequities before the IPO happens because the valuations are lower and topping up executives is not as costly or visible as after the IPO.

8.

Don’t expect to fix the “inequities in equity” after the IPO – It’s simple math. 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 equal footing in this regard.

7.

Don’t think in terms of reloads post-IPO – Those who made it big on the IPO can’t expect to replicate that experience post-IPO. With one of my IPO clients, the CEO expected to be “topped up” after taking money off the table post-IPO. My view was that the “top up” was not warranted as it would have led to overcompensation.

Here's How to Start Investing in Pre-IPO Stocks

Compensation Committees should not fall into the trap of thinking that they need to “reload” executives as a result of equity liquidations following an IPO.

6. Plan for declining burn rates and overhang – A burn rate is the percentage of shares that a company uses annually for incentive grants.

Why is post ipo equity higher than pre ipo

Overhang is the percentage of shares that are outstanding and available for incentives. In other words, overhang is a “sharing ratio” or percentage of the company that shareholders are sharing with employees.

The fact of the matter is that both burn rates and overhang are higher for pre-IPO than post-IPO companies. Overhang comes down as employees exercise their options and take gains off the table following the IPO.

What Are Pre-IPO Shares?

So, IPO companies need to carefully budget their equity usage and manage to a declining burn rate and overhang over time.

5. Consider pay structures to be your friend – High growth IPO companies often eschew anything that is perceived to constrain creativity.

Why is post ipo equity higher than pre ipo

But establishing a pay 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).

4.

Trading in the Open Market

Expect to redesign the short-term and long-term incentive plans In my experience, venture-backed companies typically focus on bookings and revenue for bonus purposes, and private-equity-backed companies tend to focus on EBITDA (earnings before interest, taxes, depreciation, and amortization).

In addition, publicly-traded stock post-IPO is a different sort of incentive vehicle than one pre-IPO, having virtually no liquidity.

How An IPO Is Valued

These issues almost always prompt a relook at the short- and long-term incentive plans as part of the IPO.

3. Aggressively manage talent – sooner rather than later – Some executives will take to the post-IPO environment like a duck takes to water.

Why is post ipo equity higher than pre ipo

Others will remain on land. It’s extremely important to determine which executives will succeed in the public environment.

Technique de trade options binaires parabolique sar

As a result, a deliberate executive assessment process, and pay actions that are consistent with these assessments, are critically important before the IPO.

2. More growth requires increased differentiation – In the early days, almost everyone is a star, or they don’t survive in a start-up or high-change environment.

Here's How to Start Investing in Pre-IPO Stocks

As the company grows, it gets increasingly populated by value maintainers that surround the value creators. As a result, it becomes increasingly important to identify the value creators and pay them at a premium.

This helps the organization allocate resources more efficiently, and also helps fill talent gaps more quickly.

1. Good governance is always in vogue – New IPO companies can get caught flat-footed if they are not prepared for the new governance environment. For example, some legal advisors still encourage IPO companies to put evergreen share authorizations into their equity plans.

Why is post ipo equity higher than pre ipo

But shareholders strongly dislike evergreens, so why establish them in the first place? My view is that it is best to establish good governance processes, preferably before the IPO happens, so that no one has to break bad habits later on.

If your company is planning an IPO this year, congratulations. My experience is that the best time to ask questions (and get answers) is before the IPO happens, not after.

Comp & Gov Spotlight

Also, it is helpful to obtain the best professional compensation advice from those who are experts, not from investment bankers or legal advisors. The good news is that it’s easy to avoid mistakes before they happen. You just have to know what they are.

_______

Robin A.

Rich forex traders in nigeria

Ferracone is the Executive Chair of Farient Advisors, LLC, an independent executive compensation and performance advisory firm which helps clients make performance-enhancing, defensible decisions that are in the best interests of their shareholders. Robin Ferracone is the author of a recently published book entitled Fair Pay, Fair Play: Aligning Executive Performance and Pay, which explores how companies can achieve better performance and pay alignment.

Robin can be contacted at [email protected].

Image via flickr.