Most companies that consider going public evaluate their executive compensation programs and agreements prior to an initial public offering (IPO). This may include executive employment agreements, annual bonus plans, equity compensation plans, or other similar arrangements. Companies that adopt a new equity compensation plan prior to going public eliminate the need for public company shareholder approval and the complexities of the shareholder approval process, including shareholder advisory firms Institutional Shareholder Services (ISS) and Glass Lewis. Please see our previous posts, Recommended Steps to Successful Equity Plan Approval: Part 1 and Part 2 for more information about the approval process for public companies. As such, private companies can be much more aggressive in their plan terms and include many provisions that would definitely draw a no recommendation from ISS or Glass Lewis if they were submitted for approval when a public company.
These provisions may include liberal share-counting terms, evergreen provisions to automatically increase available shares under a plan, liberal change-of-control terms and vesting, and the ability to reprice options without shareholder approval, among others. In our experience, practitioners and compensation consultants have regularly advised pre-IPO clients to take advantage of these provisions, but this advice may be changing. In fact, we have noticed that some companies are changing their approach given ISS’s and Glass Lewis’s influence on shareholders and the general approach to executive compensation today.
Some may ask, why not take advantage of these provisions? Many companies appear to be taking more of a hybrid approach to get on the path to good pay governance at an earlier stage to essentially ease into the process and avoid the shock at a later date. For example, a company may include an evergreen provision in its plan to give it the share flexibility but take a more conservative approach on change-of-control provisions, such as eliminating single-trigger vesting and not permitting repricing without shareholder approval. Under this approach, when a public company submits for shareholder approval at a later date, the required plan changes may be minor (maybe removing the evergreen) to receive a yes recommendation from ISS or Glass Lewis—lower shock factor!
Although no one can predict the equity plan approval process for public companies in the future, it is evident that the process has become more complicated with ISS and Glass Lewis, and we have every expectation that this process will continue to change and remain complex. In fact, just last year, ISS completely reworked its methodology for reviewing equity compensation plans. For more detail, see our White Paper. Companies clearly are becoming more educated and aware of this evolving process and the focus on good pay governance, and some appear to be taking steps in the pre-IPO stage to address these considerations.