For companies preparing to go public, either through an initial public offering (IPO) or a merger with a publicly traded special purpose acquisition company (SPAC), there are several important and strategic compensation-related issues to consider.

In our experience, the top four are:

  1. The articulation of the compensation philosophy (including the peer group used to establish competitive pay levels and practices)
  2. The design of the annual incentive program (where relevant)
  3. The mix of equity to be granted to executives, non-executive employees, and board members
  4. The share reserve structure

Define a philosophy that aligns with the organization’s business and talent strategies

As a starting point, it is important to obtain collective agreement on the organization’s approach to paying its executives, non-executive employees, and board members. A compensation philosophy forms the foundation of a rewards program and is influenced by the company’s unique business and people strategies. It should reflect the perspectives of the organization’s stakeholders (e.g., board members, management, and major investors, where relevant) on how to attract, retain, motivate, and reward employees.

The following are critical factors to be addressed:

Design an annual incentive program that aligns management with organizational success

In many companies preparing to go public, incentive programs are simple, discretionary, and ad-hoc, often due to the challenge of setting performance objectives early in the business lifecycle. In these instances, incentives are used more as a reward than a performance motivator.

As a company matures, establishing a more structured incentive framework with annual and longer-term components will reinforce organizational alignment with key performance indicators (KPIs). After all, you get what you pay for.

Performance Measures. When establishing an annual incentive plan (AIP), start with understanding your major success milestones and key financial indicators over the next 6–12 months and prioritize the most important 3–5 KPIs. For some organizations, setting annual objectives may be too challenging. In these instances, consider a quarterly or semi-annual bonus program, with a year-end true-up to manage variability.

Differentiation. Consider how much variability—in both performance and pay outcomes—is appropriate and how much, if at all, employees should be differentiated on their individual contributions (i.e., the relative weight on individual vs. corporate performance in the annual plan).

Pay for Performance. It is essential to scenario test the program under various performance conditions to ensure appropriate pay for performance alignment and identify potential affordability concerns (in which case, an earnings threshold level of performance may be required—often called a “circuit breaker”).

Governance. It is also important to conduct a thorough review of how performance measures interrelate and incorporate sufficient governance features (e.g., payout maximums), to mitigate unintended consequences, such as employees making the “wrong” decisions on behalf of the organization solely to increase annual bonus payments.

Establish equity grant guidelines with a risk/reward profile that matches the business strategy and stage of lifecycle

Frequency. In establishing the equity strategy, many companies consider peer practice, expected share price growth, dilution, and potential market volatility. For example, some organizations set annual (or even quarterly) equity grant guidelines with overlapping vesting periods to smooth cash flow, increase the retentive value of outstanding awards, and manage dilution. Others may opt for multi-year “mega grants” on a less frequent basis to take advantage of lower strike prices in earlier years and/or to deliver the most competitive on-hire offer.

Eligibility. While the “equity-for-all” mindset may be common among pre-IPO companies, it may not be the most effective use of capital. In some cases, particularly for early-career employees who require greater certainty/liquidity, compensation delivered in long-term equity vehicles (which come with an element of risk) may be perceived to be less valuable than cash, even with future upside potential. It is important to understand (and not assume) what employees value most to inform whether eligibility for the equity program should vary by level and/or business function. This extra step ensures your pay programs deliver the optimal return on investment.

Vehicles. For equity plan participants, consider the appropriate balance of equity vehicles, shaped by the company’s stage and growth trajectory and employee profile.

Stock Option: a right to buy a share of the company in the future (once time restrictions have lapsed) at a stated fixed price. The value to the option holder is the appreciation in value of the stock only (not the full value of the share).

RSU: a notional interest in a share of the company which is restricted for a period of time (vesting). Upon vesting, the unit pays out as a share or the equivalent cash value.

PSU: an RSU where the ultimate number of units that vest at the end of the performance period may increase or decrease based on the achievement of other performance conditions (e.g., earnings growth)

Structure the equity reserve in a flexible manner, balancing talent recruitment/retention needs and responsible dilution

The approach to equity granting (frequency, form, mix, eligibility) will impact shareholder dilution and the longevity of the share reserve so it needs to be carefully modelled and considered under various share price performance and headcount growth scenarios to ensure there are no major surprises down the road.

Generally, it is important to incorporate as much flexibility in the plan as possible while ensuring it continues to have appropriate governance and dilution management features in place such that it is acceptable to investors and proxy advisors. Ensure the plan is written to incorporate multiple forms of equity (e.g., options, RSUs, PSUs, and DSUs) and settlement (cash or equity), even if you don’t plan to use them all at the outset.

Among organizations going public on a Canadian exchange, it is a prevalent practice to establish a 10% share reserve. However, several factors should be considered in determining the size of the reserve, including peer/industry practice, investor profile and preferences, and other design features (e.g., the inclusion of practices like liberal share recycling and single trigger change in control may require an offsetting decrease in the size of the share reserve). The two most common ways to structure the share reserve are:

For companies merging with a SPAC, the plan needs to be approved upon transaction; however, based on our experience, shareholders are more liberal in what they support in these instances, as compared to larger, more established publicly traded companies.