Compensation of executives in a pre-IPO company

The startup you work for is gaining more acceptance in the market and with remarkable growth you are now considering the prospects of an IPO. The fruits of your team’s labor are at your fingertips. But do you know how your executive compensation program will it change by becoming an employee of a public company? What rewards should you expect at the IPO stage?

Alternatively, your business unit can be sold from its parent company in the form of an IPO. How your conditions of employment for executives and the change in remuneration?

Compensation in shares of public enterprises

The compensation of executives of state-owned enterprises is subject to review by the SEC and public shareholders. Specifically, the Compensation Analysis and Analysis (CD&A) section of the public company’s proxy circular will outline how senior executives are compensated. In addition, shareholders also have an advisory vote on executive compensation matters, called a “Say on Pay” vote. Therefore, the design and structure of the compensation of senior executives of state-owned enterprises must also meet public expectations.

Executive compensation programs generally contain cash and stock compensation. For public companies, equity is readily available and its value is determined by the market. Because stocks are publicly traded, post-IPO stocks provide executive liquidity and are subject to a blackout and SEC rules, such as those against short swing profits and insider trading. .

Equity is often the most important component of executive and executive compensation programs. Executives are typically compensated based on performance, measured by multi-year corporate goals based on finance / market.

Capital remuneration of private companies

For private companies, equity compensation often takes the form of limited stock and stock options, as well as stock options vested at performance. Private companies in the pre-IPO phase often pay less cash compensation because they are less well funded than the post IPO company. The gap is often bridged by equity.

Compensation in shares of executives in a private company has the disadvantage of being illiquid. Yet, it can also have important advantages that make it attractive to join a private company before the IPO.

An advantage of equity in a private company before the IPO is valuation. Since the share is not traded and its value has not yet been set by the public market, the Board has some flexibility in valuation. Generally, executives who receive common stock will benefit from a significant discount on the valuation of preferred stock issued to investors. This discount would be confirmed in the IRC Section 409A assessment.

The other advantage of participating in a private company is the possibility of a significant tax-advantaged gain. Often times, the IPO will see a sharp increase in the price of the shares. Then, depending on the structuring of the shares, the shares issued by private companies offer a greater potential for favorable tax treatment of capital gains. This is especially true with the tight stock.

Transition to a public company

In preparation for the IPO, a private company will design a new executive compensation program to meet government requirements and investor expectations. This is usually done by comparing with a group of publicly traded companies. During this transition, the pre-IPO private company, which often uses restricted stock and stock options for executive compensation, will gradually shift to executive compensation in performance-vested shares. Since it is difficult to set multi-year performance targets for the newly formed public company, the actual transition may take a few years after the IPO.

If significant equity had not been granted in the years preceding the IPO, or if most of the exceptional grants will be fully vested at the time of the IPO, a special equity grant or a “ attribution of the founders ” is often granted to the executives at the time or approach of the IPO. This increases the equity holdings of senior executives to levels typical of a public company and provides an incentive for executives to stay during the critical IPO period.

Key employees, employees who are asked to perform additional duties during a period related to the IPO, and employees at particular retention risk are likely to receive special retention incentives or incentives to retain. the transaction. Again, for the maximum tax benefit, restricted stocks, often referred to as founding stocks, are desirable.

Negotiate the remuneration of your executives in the pre-IPO company

So if your business is considering an IPO, what should you do to protect your interests? Clearly, as stated above, you should be looking for a retention agreement with equity capital taxed to the extent possible.

How much should you get paid? You should be aware of executive compensation in comparable companies. But if that is not possible, looking for a package that is not out of step with the structure of the company but at the same time commensurate with your value to the company and the success of the IPO is a good idea. reasonable goal. If you are instrumental in the success of the IPO or at least a significant player in the success of the company and the team presented to investors, this should provide the leverage necessary to achieve these conditions. required.

How do you structure your compensation in stocks as the value of stocks increases? My previous articles deal with the structure of your shares in restricted or RSU to enable the executive to realize the sharp rise in stock prices associated with an IPO as a capital gain event rather than ordinary income.

Bonuses can also be a key part of executive compensation in public companies, and the private company before the IPO can update your bonus structure. My previous article on structuring executive bonuses may also be of use to you.

What other equity-related terms to look for before the IPO? Beware of clawback clauses in your executive employment contract, but also look for pro-executive clawback clauses and ramp-up terms on your C-level or senior executive equity program. Because as stated above, the benefits of the IPO can be so huge, you want provisions that give you that advantage if you stay until the IPO and also if you are. finished before, but still contributed a lot to the success of the company.

Additional employment conditions to consider after the IPO

After an IPO, if your management team is successful in creating shareholder value, your business may become a target for acquisitions. Your executive employment contract should also include terms that protect your interest in this type of change of control situation. If your business is “on the line” at some point after the IPO, you might want to check out my previous articles on change of control agreements and retention agreements.

The structuring and negotiation of executive compensation are complex issues and should be treated with caution. It is wise to seek the advice of an experienced executive compensation lawyer.

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