IPO Equity Compensation Rollercoaster!
Although the stock market has remained strong, we’ve had a few week years when it comes to IPOs. This post is just a reminder of things any pre-IPO compensation or HR expert should know about what the world is like for the year after your IPO.
IPOs and equity compensation have become almost mythical in the media and entertainment. Because of this they are often mythical in the eyes of your employees. We have all read about the massage therapist, artist or receptionist who became multimillionaire when their company went public. We have all see the headlines about twenty-something billionaires.
But, the reality of an IPO for non-founders today is often different than those legends. Companies going public are increasingly mature. The average time to going public ranges from 10 to 12 years (depending on your source). Age and size mean far more employees than those of the “Dotcom” heydays, or even the pre-financial crash era. Markets are also far less forgiving. Information moves faster, projections are more precise and the rules and regulations are bigger hurdles.
Even with all of that, pre-IPO companies have essentially the same pay tools that have been defined for decades. ISOs, Nonqualified Stock Options, Restricted Stock and RSUs. These are the common equity building blocks of a company on the path to IPO. There are other tools, but most awards are standard.
Most companies with IPO aspirations begin by granting time-vested stock options very early on. The strike price (also called grant price and exercise price) is based on a 409A complaint value and is usually incredibly low. But when a company is ramping up to IPO the values are much higher. Some companies have 409A values, or investor derived values high enough to be troublesome. When the pre-IPO price is close to the potential post-IPO price equity compensation can deliver more of a thud than a bang.
This interesting article provides an interesting look at post-IPO companies. Look at the randomness of post-IPO stock prices. Many companies see their stock price depressed long after the glow of the IPO has faded. This happens in half or more of IPOs. For companies who grant late stage pre-IPO stock options this can result in “underwater” options before the options are even vested. Watching your stock price drop after an IPO is demotivating. Watching your stock option value disappear is downright depressing.
Over the past several years RSUs have become more popular in the year, or more, running up to a potential IPO. RSUs eliminate the stock price hurdle, but take away much of the flexibility on the part of the individual. Instead of allowing an elective transaction to acquire the underlying value, like stock options, RSUs require value transfer (and associated taxes) when they are vested. This sounds fine until you are 6-18 months post-IPO with a weak stock price that has started to recover. Vesting may occur right when employees are starting to see the light shining brighter. Nothing like getting people excited then whisking the exciting away!
When you add the post-IPO lull to share allocations that may have pushed investors goodwill, simply due to the time and size it takes to become publicly traded company and you have the recipe for a swift change in compensation philosophy or a messy period of poor retention and difficult pay conversations. While all this is happening, you will also have early equity holders celebrating in the streets (in their fancy new cars.) It’s enough to frustrate even the most mindful* compensation professional.
At this point you are thinking: Thanks for the bad news Danny-Downer! But, just a few things can make all of this go away or at least become less of an issue.
1. Stock Options, RSUs and equity compensation general are still amazingly powerful ways to pay employees. The challenges should not keep you from a successful program.
2. Start early. Start calculating the real equity you will need to go public successfully. Start analyzing the potential use of RSUs and other equity immediately after granting your first set of stock options. Start learning about every detail of equity compensation now.
3. Communicate. Make sure your executives understand the potential paths for your equity compensation. Make sure your employees can understand and perceive the value and risk of their grants. Make sure your investors have data regarding IPOs in your industry as they occur. The important equity details are filed publicly.
4. Plan. Project future staff growth and its impact on your equity pool. Look at your grant levels and determine if your philosophy can be supported by what your investors will allow to grant (start modeling with 15%-20% maximum overhang and see how far you can survive.
Most importantly know when your newly granted equity awards are maturing from potential lottery tickets, to possible college loan payoffs, to potential new cars and when they are more likely to be enough for a nice knife set or short vacation. Understanding the future potential of your equity awards is the key to post-IPO success.
*I just felt like I had to be in the cool crowd and use “mindful” in a sentence.