Evolving Your Compensation Plan on the Road to IPO

Compensation is one of the areas that often undergoes a major facelift during and immediately after an IPO. The CHRO often leads this important transition, overseeing everything from reviewing and redesigning the equity plan, to establishing board, executive, and non-executive pay strategy and helping to build the compensation committee. To manage this effort, the CHRO needs reliable partners inside and outside of the organization and can often benefit from starting the process early with a proactive strategy.

A gathering of executives in The Circle led by two compensation experts – Ralph Barry (Principal at Compensia) and Chris Tobin (Advisor and former CHRO of Intercom) – revealed some of the key areas that CHROs will want to address as they lead the compensation plan evolution leading up to an IPO.

1+ Years From an IPO

Before the meat of the IPO readiness process begins, CHROs set themselves up for success by taking a proactive approach to a few key areas: 

• Evaluating Retention Among Key Employees. As a company nears an IPO, employees are going to re-evaluate their financial incentives. For CHROs, this is a critical opportunity to evaluate the retention profile of key employees to identify who is at risk of attrition. Ralph often advises CHROs to review equity value and vesting schedules at the individual level to see if improvements can be made. Both Ralph and Chris agreed that starting this exercise early is key as it becomes increasingly challenging to get board members and legal sign-off on one-off compensation increases the closer you get to an IPO. 

“A year out from going public, you have a chance to do some interesting things to lock in retention while also driving meaningful wealth creation for your key employees.” – Ralph Barry, Principal at Compensia

• Understanding Objectives and Process Gaps. Around a year out from a planned IPO, most companies bring in an accounting firm (usually one of the Big Four) to conduct a comprehensive IPO risk assessment. CHROs should be involved in these conversations to familiarize themselves with their role in the IPO readiness process and identify any major HR systems and processes that may need to be overhauled. CHROs can also use this time to evaluate compensation consultants to bring on as a strategic partner.

6-12 Months From an IPO

Within a year of an IPO, the CHRO gets more intimately involved in transitioning the compensation plan. Here are a few of the main areas that they will focus on: 

• Building a Compensation Peer Group. To compete with other public companies, compensation programs need to benchmark against relevant companies of a similar size or stage. This can be tricky as you transition from private to public because the CEO or CFO may be inclined to benchmark against competitors that are much larger companies (think “FAANG”) with bigger compensation budgets. “There’s an ego component to it,” explained Chris. In this situation, it’s the CHRO’s role to lead with a data-driven strategy and get leaders to agree on a realistic peer group. “When you actually show your CEO or CFO the compensation data for larger competitors, it can help to bring them back down to Earth.” Keep in mind also that, at this stage, you’re primarily benchmarking major compensation initiatives like executive compensation, board pay and equity burn rate, not the company-wide compensation strategy. Ralph often recommends companies continue benchmarking against similar late-stage private companies to connect the dots between how competitive their pay structure is today and where it may need to grow over time.
• Assessing Executive Compensation and Non-Executive Equity. With a compensation peer group in hand, the CHRO is going to drive a comprehensive compensation analysis that concentrates first on the executive cohort. This analysis will help identify retention issues and gaps relative to market and pay philosophy and highlight potential strategies to address them. For non-executive employees, there likely will need to be significant changes to things like equity grant guidelines, refresh cadence, and equity mix that will need to be modeled out to examine the tax and cashflow impact. Often, determining when and how to transition from options to RSUs is one of the more significant outcomes of this analysis. There could be a number of factors driving this decision – from investor concerns around dilution to a fast-moving 409A valuation that’s driving up the exercise price. Before rolling out any changes to the equity program, it’s important for CHROs to evaluate both the impact of this transition on the overall equity plan and the tax implications and incentive value impacts for employees.
• Employee Communications. Throughout this stage and as you start to introduce changes to the pay philosophy or equity plan, employees are going to have questions. While most CHROs will want to keep the details of the IPO close to the chest, there can be value in being more transparent and starting to educate employees on what their equity and total compensation might look like in a post-IPO world. As Chris explained:

“You need to get really clear about how you describe value to employees. If they’re used to options and you’re moving to RSUs or another vehicle, you need to talk about how you value that equity and benchmark it. Equity is always a hot topic and one that we have to spend a lot of time educating employees on.” – Chris Tobin, Advisor and former CHRO of Intercom

• Reviewing Severance and Change of Control Agreements. If your company offers certain cash or equity-based rights tied to an involuntary termination or change of control, it’s important to review those agreements far enough in advance of going public. Any company-wide policy will likely need to go into your S-1 because if you wait to disclose it until after you’re public, it might require the filing of an 8-K filing which can raise questions among shareholders. At the same time, having a policy for these types of agreements can help to protect key executives in the event of a sudden acquisition and mitigate any contentious negotiations with existing employees or new hires.

3-6 Months From an IPO

Heading into the final sprint of the IPO preparation process, the CHRO starts to shift focus to some of the finer points of the compensation strategy, such as:

• Forming a Board Compensation Framework. Non-employee public company board members typically receive compensation for their service either in the form of cash or equity. In addition to helping to identify independent and Committee board members, the CHRO often helps to develop the board compensation structure. There are a number of ways to do this – and your CEO will almost certainly want to be involved – but Ralph advises clients to follow a market-based framework.
• Developing Employee Stock Purchase Plan (ESPP) Terms. After developing the compensation guidelines, peer compensation group, and employee and executive compensation assessment, the CHRO and their team get to work building the new post-IPO employee stock plan. This company-wide plan will outline everything from the equity grant strategy to the company’s share reserve size, share purchase limitations, refresh policies, equity burn rate, and more. This exercise will take a significant chunk of time, which is why many companies will outsource a lot of the analytical work to compensation consultants.

The Takeaway:

There are a litany of individual tasks and decisions that the CHRO will lead when transitioning a company’s equity plan from private to public. Understanding the scope of work and starting the process early and ultimately drive a better outcome, and it’s important to leverage trusted partners that can help streamline the entire process.

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