COMPENSATION AT WORK

Managing expectations in an IPO

There are sensitive, and subtle, issues that the compensation committee will need to anticipate.
BY ROBIN FERRACONE AND RON BOTTANO

IPOs like LinkedIn, Pandora, Zillow, and HomeAway have valuations that range from 5x to 15x projected revenue and defy gravity. On the heels of these recent IPOs, the financial press is filled with news about other eagerly anticipated offerings from such companies as Groupon, Zynga, Kayak, and LivingSocial. But once public capital is raised, it must be profitably deployed. While sometimes described as an exit, an IPO cannot be viewed as such by the management team who must execute the strategy to support the lofty expectations embedded in the companys stock price. To sustain soaring growth and prove out their business models, these companies must plow capital into exceptional talent who can lead and scale the sales, marketing, product development, and operations functions. In compensating that talent, its easy to think that the most signicant postIPO challenge will be handling the volume of new hire offers. But the fact is that there will be other more subtle issues that the compensation committee and board will need to anticipate. For example, in one recent IPO situation, the CEO expected to be topped up with stock options in order to preserve the same ownership percentage that he had prior to the IPO. Was this claim a shrewd negotiating ploy, or an innocent misconception? Either way, the compensation committee had to explain to the CEO (over a series of conversations) that as with most IPOs, the executives would not be topped up, and additional dilution of the managements ownership stake would likely occur from future
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stock issuances following the IPO. Theres also the matter of the haves (i.e., those who got rich on the IPO) and the have-nots (i.e., those who came into the organization after the IPO). After the IPO, there are likely to be diverging wealth accumulation opportu-

Robin Ferracone (left) is the executive chair and Ron Bottano is a vice president of Farient Advisors LLC, an independent executive compensation consulting rm (www.farient.com). Ferracone is the author of the book, Fair Pay, Fair Play: Aligning Executive Performance and Pay.

nities. The best thing to do is to just play it straight and let people know that its not realistic to think that there will be parity in executive wealth. Why? Because the risk wasnt the same either. Instead, the compensation committee is better off focusing on what people can expect. They can expect that the company will treat people fairly relative to the market and relative to each other in salary, annual bonus, and annual equity grants going forward. Moreover, they can expect that there will still be very attractive upside opportunities as the company grows and realizes its potential. LinkedIn is a good case in point. For the two years prior to the IPO, the top exec-

utives received no salary increases, with salaries varying by only $25,000 from the CEO to the top four ofcers. Instead, LinkedIn relied primarily on option grants to motivate and recruit its executive team. Post-IPO, salaries increased by 25% to 90%, with a more competitive cash pay structure that differentiates by executive role. Moreover, equity grants are likely to become an annual, rather than episodic, event, at least for those not receiving initial new hire grants. Another issue that is likely to come up is around retaining those individuals who are wealthy enough to retire and go to the beach, or who are ready to jump ship for the next big hit when the next sexy IPO comes along. In this case, it is incumbent upon the compensation committee to, in effect, change the conversation from the big hit to how the executives creativity and imagination will be used in the next exciting role, and how there is plenty of upside still ahead. Finally, compensation committees can expect that public shareholders will demand accountability on how performance will be measured in order to justify incentive awards. The latest wave of public offerings showcases this discipline, with companies shifting from completely discretionary pre-IPO cash bonuses to a post-IPO bonus structure that rewards specic nancial and commercial targets (such as registered members, active accounts, revenue, and EBITDA margin) to partially discretionary incentives (say, 50% quantitative/50% qualitative). IPOs can be a terric means to provide growth capital, and to recognize those who helped build the value of the enterprise. Nevertheless, there are challenges in the aftermath of the IPO. With the benet of foresight, good compensation planning, and straightforward communications, expectations can be successfully managed for the benet of the shareholders and the executives and employees alike.
The authors can be contacted at robin. ferracone@farient.com and ronald.bottano@ farient.com.