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.
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:
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.
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.
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.
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.
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:
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.
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:
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.