Alvarez and Marsal

Human Capital Today

SPAC and Traditional IPO Executive Compensation Considerations When Going Public

J.D. Ivy, Managing Director

Brian Cumberland, Managing Director

Allison Hoeinghaus, Managing Director

Vance Yudell, Director

Andy Burdis, Senior Associate

March 30, 2021 / North America

Even in our current volatile economic environment with uncertainty still surrounding COVID-19, transaction activity continues to occur, particularly with respect to special purpose acquisition companies (SPACs) and traditional initial public offerings (IPOs). Companies considering or preparing to go public should ensure they are prepared with appropriate and market-based compensation structures.

2020 saw a remarkable increase in the utilization of SPACs. In 2020, approximately 250 SPACs were launched, a more than four-time increase from the number in 2019. Nearly 50 percent of the IPO market in 2020 was as a result of SPACs. A large reason for this explosion in SPAC activity is due to their cheaper fees as opposed to a traditional IPO, as well as a faster and simpler route of going public. More than 130 SPACs have already been launched so far in 2021, so the trend looks to be continuing in the short term, but it remains to be seen how long this surge in activity will last.

SPACs also have to navigate the additional step after IPO of identifying a private company merger target. The process of searching for a merger company usually must be done in less than 24 months (although most mergers occur prior to this point). The chart below illustrates the process for a SPAC from IPO, to search for a target, to finding a target, and then to completing the business combination (“de-SPACing”). Given the huge increase in SPAC launches in the past year, the next couple of years are primed to be packed with de-SPACing transactions due to the typical 24 month deadline for a deal.

Regardless of whether a company enters the public realm via a de-SPACing transaction or the more traditional IPO route, the way a company should prepare from a human capital and an executive compensation perspective is very similar. Below are the key compensation considerations for all companies preparing to go public. At the end, we also highlight a handful of unique differences to watch out for in de-SPACing transactions.

Setting the Stage

Before a company begins setting compensation for its key executives and employees, it needs to scope out the competition. First, it should investigate what levels and types of compensation are going to be competitive, so its compensation structure does what it is supposed to do: incentivize and retain key performers while at the same time maximizing shareholder value and the interests of other stakeholders. This involves developing a peer group of companies to assess market-based compensation. Second, companies need to be aware that institutional shareholder advisory groups — such as Institutional Shareholder Services (ISS) and Glass Lewis — serve as critics in determining whether a company has done a good job in setting compensation. These groups continue to influence executive compensation trends by annually defining “best practices.” Hot button issues right now involve the use of board discretion in incentive programs; links between pay and performance; environmental, social and governance (ESG) metrics; and tax gross-ups.

Before developing short-term and long-term incentive programs, companies should:

  • Develop an executive compensation philosophy: Companies should develop a philosophy regarding how they want to compensate their executives relative to market. Many companies may choose to target the 50th percentile, whereas others may target higher levels. Further, how a company wants to deliver its compensation should be determined. What is the appropriate allocation for fixed and variable compensation, as well as equity and cash compensation? For example, at most public companies, the higher up an individual is in the organization, the higher percentage of his or her pay is “at risk” or variable. In particular, equity usually makes up a majority of executives’ target compensation packages in the C-suite in order to align their interests with those of shareholders.
  • Develop a peer group of comparable public companies: In benchmarking compensation, a company should generally consider how its peers compensate their executives. How does a company know who its peers are? It compares itself to other similar companies based on industry, revenue, enterprise value, market capitalization, total assets and/or employee headcount. It is preferable to include companies that fall within acceptable ranges using some combination of these factors as a guide. The combination of factors utilized varies based on industry and even sub-industries.
  • Review competitiveness of and set executive compensation: Competitive levels are typically set by analyzing the compensation information for peer companies, using either proxy and/or survey data, and aligning recommended levels with the company’s compensation philosophy. Compensation levels should be set for base salary, target bonus, equity or long-term incentive awards, perquisites and other benefits. It is important to compare total compensation when measuring against the peer group.

Short-Term Incentives

Short-term incentives are a critical part of any compensation package. Therefore, companies should develop a formal short-term incentive plan document that sets forth the performance measures that will be used to determine whether an executive’s performance warrants the award of a bonus, as well as to determine the amounts to be paid upon achievement of the set performance targets.

Companies need to select the financial performance measures they will use and individual performance goals each executive must achieve. In general, performance metrics should align management with the overall objectives of the company. This can include financial metrics such as adjusted EBITDA, revenue or free cash flow; operational metrics; and/or individual metrics based on key milestones for each executive in a given year. However, this is not an exclusive or exhaustive list.

Long-Term Incentives

The next step is to review and develop a long-term incentive strategy, which includes determining how much and what type of long-term incentives will be used and the appropriate instrument use or mix of alternatives. Prior to going public, the compensation committee should develop a long-term incentive award matrix with values for all employee levels. It should also set an equity utilization (burn rate) budget for the coming fiscal year as well as calculate the dilution and overhang that results from the reserving of equity awards. Burn rate is measured as shares granted divided by total common shares outstanding; it generally reflects the dilutive effect of equity grants. ISS sets burn rate caps for public companies generally based on size and industry. Also, during a traditional IPO or a de-SPACing transaction, it should be determined whether any IPO awards will be made, to whom, and in what amounts.

Executive and Board Stock Ownership and Holding Requirements

The pre-IPO company should consider whether to implement stock ownership and holding requirements. Ownership guidelines typically dictate how much stock an executive or board member must acquire within a specified period of time (usually three to five years). These guidelines are typically defined as a multiple of annual base salary or the ownership of a fixed number of shares. Holding requirements mandate executives retain a certain percentage of shares they acquire through the exercise or vesting of stock options, restricted stock and other equity awards. These guidelines help align shareholder and executive interests.

Severance and Change in Control Plans

Pre-IPO companies should review existing employment, severance and change in control (CIC) agreement terms, conditions and potential payout obligations. Depending on how these agreements are drafted, it is possible that payments or vesting of equity may be triggered by the IPO itself or upon a qualifying termination or resignation in the period of time leading up to, or following, the IPO.

The company should also complete a competitive analysis of key terms for employment, severance and CIC agreements and set terms going forward based on the market. As an example, typical severance protection upon a change in control is commonly set at 2–2.99 times either base salary or the sum of base salary and bonus for the CEO (average ~2.4) and 2–2.99 times for the CFO (average ~2.1) per A&M’s 2019/2020 Executive Change In Control Report (A&M’s CIC Report).

For CEOs and CFOs, the value of severance paid upon termination in connection with a CIC is on average 1.34 times (CEO) and 1.38 times (CFO) the value of severance paid upon a termination without a CIC (A&M’s CIC Report). However, CIC and non-CIC severance practices vary significantly based on company size and industry so it is critical to have a full grasp on what is competitive yet reasonable within your specific peer group, as compensation payable upon termination must be disclosed in the company’s proxy on a go-forward basis.

New Regulatory Requirements

As a new public entity, there are several rules and regulations that will now apply that the company may have never addressed when it was private. Many of these regulations can be complex (especially initially), and it takes time to digest and analyze the impact of these provisions, such as:

  • Code Section 162(m): Under Section 162(m), no deduction is allowed to any corporation with publicly held debt or equity for compensation in excess of $1 million paid to any covered employee (the principal executive officer, principal financial officer and the top three highest-paid other executives) in a taxable year. Historically, companies that recently went public could take advantage of a transition exception for several years for certain compensation arrangements that existed while it was private. With this IPO exception now eliminated, companies will need to be prepared immediately to start tracking covered employees as to their compensation each year and any limitations on the deductibility of those amounts. For more detail regarding Section 162(m), please see the article The Fog Has Lifted: The IRS Issues Proposed Regulations Under 162(m).
  • SOX compliance: To comply with the Sarbanes-Oxley Act of 2002, any outstanding personal loans between executives and the company should be eliminated prior to going public.
  • CEO pay ratio: Public companies must comply with pay ratio disclosure rules, which require public companies to disclose the following: (i) the annual total compensation of the median employee (excluding the CEO) of the issuer, (ii) the annual total compensation of the CEO and (iii) the ratio between the two amounts. These rules have significant flexibility, and it is generally advisable to maintain a consistent methodology year to year (if possible) to avoid wild swings in the ratios, so upfront modeling and analysis are important for this disclosure requirement.

Other Considerations

In connection with an initial public offering, the company will need to address several governance issues, including the preparation of the compensation discussion and analysis portion of the S-1 and proxy disclosures and the compensation committee charter.

The company should set the equity award approval process, including what authority, if any, will be delegated to management. A policy regarding award grant timing should be formalized, and a compensation calendar should be developed, identifying when the company will: grant long-term incentive awards, implement salary increases and approve annual incentives, as well as when the compensation committee will meet. Board of directors’ compensation for the following year should also be reviewed and set.

SPAC Specific Considerations

How a company should prepare for a de-SPACing transaction is very similar to that of a traditional IPO, but there are a few distinctions that are important to consider:

  • Timing: The biggest difference between de-SPACing transactions and traditional IPOs is usually timing. In general, once a target is identified, the timeframe to put together an executive compensation and human capital strategy is on a more accelerated timeline for de-SPACing transactions than a traditional IPO. This makes early preparation vital during the compressed timeline.
  • Disclosures: Although an S-1 is filed in both a traditional IPO and a SPAC, SPACs have additional disclosure requirements related to the de-SPACing event. Upon the negotiating of a deal to acquire a target company, a proxy is generally filed if a shareholder vote is required, and if not, a tender offer is generally filed. Once the acquisition is approved and finalized, then an 8-K is generally filed with the SEC to consummate the transaction. A substantial portion of these various disclosures revolves around executive compensation at the target company both historically as well as on a go-forward basis.
  • SPAC Tax Considerations: Section 280G and Section 4999 of the Internal Revenue Code: For target companies of SPACs, it is imperative to evaluate their agreements and plans to determine whether the de-SPACing transaction will constitute a change in control under those arrangements. If a change in control is deemed to take place, it is important to evaluate any potential golden parachute payments to target company executives to ensure that any payments do not trigger adverse tax consequences under Section 280G and Section 4999 of the Internal Revenue Code. These code sections put limits on the amounts that can be paid to executives in the event of a change in control without triggering a 20 percent excise tax and should be evaluated in any change in control transaction.

Alvarez & Marsal Taxand Says:

There are many issues a company should consider when preparing for IPO readiness, whether through a de-SPACing transaction or a traditional IPO process. Boards of directors and compensation committees want to be perceived not as providing excessive compensation packages relative to their peers, but rather as appropriately incentivizing and retaining key executives while at the same time maximizing shareholder value and the interests of other stakeholders. Be on the lookout for A&M’s soon to be released IPO executive compensation survey. This survey not only covers the compensation amounts for recently IPO’d companies, but also details the structures of compensation programs, bonus plans, and equity awards.

A&M Senior Associate, Andy Burdis, contributed to this article alongside the authors. 

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