It may not be the sexiest topic related to IPO, but it's important not to neglect your equity compensation when you're thinking of going public. The last thing on the list can be the first thing that gets you pinched. Originally presented at Synergy 2014, this deck was developed by experts from four firms (Radford, PwC, Cooley LLP and Solium), and is loaded with indispensable information. Don't go public without it!

1. The IPO Journey & Stock Compensation
Getting There is Only Half the Fun!
October 22, 2014
1
Christina Chiaramonte, Solium Mike Gould, PwC Laura Lakin McDaniels, Cooley LLP Ken Wechsler, Radford

2. Outline
•
Overview of the IPO process
•
Review the Governance, Financial, Legal, Compensation Design and Administrative areas while on the Road to an IPO
•
> 12 months pre-IPO
•
6-12 months prior; 3-6 months prior; IPO imminent
•
Questions & Discussion
•
Appendix
•
Accounting and Reporting Issues
•
Governance 2

3. An Overview of the IPO Process 3
Pre-Effective
Post-Effective
Phase 1
Pre-Kick-off/Planning
Phase 2
IPO Process Execution
Phase 3
Post IPO/Public Company
•
Initial planning and preparation
•
Readiness assessment
•
“Going public”
•
Execution of the IPO process
•
“Being Public”
•
The organization to be to transformed to enable it to operate as a public company
IPO effective
IPO Pricing

4. Detailed Illustrative Timeline 4
Kick- off
Effective date
Registration
Financial reporting
Structuring
Audit
Underwriter
Preparing to be public
Offering team selected All-hands meeting held
Project governance established
•
Roles and responsibilities defined
•
Project plan completed
•
Communication plan established
•
Issue resolution process agreed
Draft Form S1, including textual information prepared
Pro forma financials drafted
Draft Form S1 finalized
Form S1 and exhibits submitted to printer/placed on Edgar
Form S1 filed
Textual information drafted
Amendment filed
Form S1 registration requirements identified
Form S1 shell drafted
Pro forma financials completed
Circle-up discussion held
Draft Form S1, including financial information prepared
Responded to SEC comments and Form S1 amended
IPO effective
Financial reporting requirements identified/ shell drafted and reviewed
Segments identified
Significant accounting/reporting issues identified
Significant accounting/reporting issues resolved
Historical financials drafted
Five-year selected data provided
Historical financials completed
Address SEC complex accounting issues
Tax structure determined Tax impact analyzed
Compensation plan for principals and employees completed
NewCo established as a legal entity
Review of Form S1 completed
Comfort letter delivered
Comfort letter prepared
Audit consent issued
Sign off shell financial statements
Complete review of pro forma financials
Annual audit and interim reviews completed
Comfort letter requirements discussed
Initial discussion regarding due diligence request list held
Working draft sessions begin
Underwriter agreement signed
Marketing and road show
Access current organization and identify resource gaps
Access financial close, systems, and internal control capabilities
Recruit key personnel; onboarding. VPs build teams
Develop implementation plan and execute
Internal control documentation and testing
Initial filing date
Tax issues impacting data requirements for SEC reporting purposes resolved
Audit planning meeting holding audit review procedures confirmed
SEC comments received

5. IPO Readiness Framework 5
Technology
Project management, change management & communications
A comprehensive IPO readiness assessment requires a thorough evaluation of all areas of the organization.
Enterprise risk management
Treasury
Legal
Tax
Executive compensation and HR
Wealth management planning
Corporate strategy and development
Accounting, reporting, and financial effectiveness
Financial planning and analysis
Governance and leadership
Internal controls & internal audit
Media and investor relations
Engage with investment banks

6. Compensation Planning IPO Milestones
Matching and Leveling to the Radford Job Platform
First Time Salary and Bonus / Equity Benchmarking
Salary Administration System Development
Annual Bonus Needs Assessment/ Design
Startup
Equity Grant Guideline Development and Total Dilution Planning
Acquisition/ Merger- Ready
Comprehensive Executive Compensation Review
>
Peer group selection
>
Compensation philosophy
>
Total pay competitiveness
>
Executive post-IPO retention assessment
>
True-up internal inequities in stock holdings
Public Disclosure and Regulatory Preparation
>
Executive compensation SEC disclosure drafting
>
Equity plan terms audit and funding needs projections
>
Tax & regulatory compliance
>
Executive severance/change-in- control policies and contracts
Board of Directors Compensation Program Establishment
Equity Holdings Retention and Refresh Assessment
Ongoing Cash/Equity Program Review and Incorporation of New Roles/ Incumbents
Equity Award Valuation Assessment for ASC Topic 718 Accounting
Initial Public Offering
Go-forward Public Company Compensation Maintenance

7. Early Stage Pre-IPO: > 12 Months Out 7
Elements
Considerations
Financial

Complete thorough IPO readiness assessment on all aspects of Going Public and Being Public

Select auditors and accounting advisors

Ensure financial statements are SOX complaint

Start to build finance team sufficient to support the needs of public company

Obtain independent valuations, if necessary

Analyze potential tax structures and determine optimal structure
Governance

Evaluate annual bonus programs and other pay practices in light of enhanced disclosure

Consider board membership (independence) and CEO role in setting compensation
Legal

Evaluate Rule 701 and “Blue Sky” compliance

Plan for repayment of officer and/or director loans prior to IPO (Sarbanes-Oxley)
Compensation

Provide new hire equity grants

Consider refresh grants for executives and staff on board for longer terms

Evaluate competitiveness of cash compensation program

Determine labor market for talent, particularly executives
Administrative

Assess sufficiency of minute books and corporate records

Consider internal roles and expertise related to equity structure

8. Pre-IPO Equity Hot Buttons
•
Rule 701/Blue Sky Compliance
•
Audit grants for compliance
•
May be required to provide enhanced disclosure with new grants
•
Cheap Stock charge/Section 409A tax consequences
•
Obtain frequent valuations – ideally a valuation for each grant date
•
Avoid granting awards when new valuation is pending
•
Resolve 409A issues
•
RSUs
•
Can be issued instead of options to avoid valuation problems
•
Avoid vesting/settlement in lock-up period 8

9. Cheap Stock
•
ASC 718 requires all entities to recognize compensation expense based on the fair value of stock awards and option grants
•
SEC may require an increase in the charge for compensation expense if the estimated fair value of recent equity awards is below IPO offering price (“cheap stock”)
•
SEC will review past 12 to 18 months of option grants or other issuances
•
Build the backup well before filing
•
Independent valuations
•
Third party transactions
•
Timing of the SEC comment can cause delays - resolve this one with the SEC before you go “on the road”
•
Potential impact on IPO valuation of non-cash compensation charges 9

10. Elements
Considerations
Financial

Write MD&A

Ensure finance team can close books and report within 45 days

Identify and agree upon number and nature of segments with all stakeholders

Identify and agree upon non-GAAP measures and other KPI's and ensure they have appropriate internal controls

Commence remediation of any material weaknesses, if necessary

Approach SEC with any pre-clearance issues, if necessary
Governance

Establish Board Committees: audit, compensation, nominating/governance

Make necessary board changes (director independence; financial expert)

Consider risk oversight disclosure requirement

“Executive” officer status – review management structure and titles
Legal

Review/revise existing employment and equity agreements (409A, change of control provisions)

Consider/draft new equity plans – “omnibus” equity plan and ESPP

Ensure all shares subject to a lock-up

D&O questionnaires – identify issues
Compensation

Conduct Board of Directors compensation market assessment / design program for forthcoming independent directors

Determine hiring of executives post IPO and compensation needs

Review and design an equity strategy for the pre- and post-IPO environment covering the broad employee population, including potential evergreen provisions and Employee Stock Purchase Plan (ESPP) programs
Administrative

Identify/hire a dedicated stock plan administrator within company or use of full-service partner

Review and “clean up” shareholder and option-holder records

Recommended: move to fixed schedule for making option grants
Pre-IPO: 6-12 Months Out 10

11. Elements
Considerations
Financial

Perform live close and deliver 10Q like document within 45 days of quarter end

Finalize MD&A, summary, selected, and other financial disclosures

Complete pro forma financial statements, if necessary

Update historical financial statements with annual and interim financial statements, as necessary

Continue working on remediation of any material weaknesses, if necessary
Governance

Committee charters should be developed/updated

Develop a compensation philosophy and a transition strategy to migrate compensation programs from private company to public company environments

Insider trading policy and window program
Legal

Draft and review a Compensation Discussion & Analysis section (CD&A) if needed

Reevaluate available share reserves under equity plans

Consider post IPO equity award mix (option vs RSUs) and tax implications
Compensation

Develop a compensation philosophy and a transition strategy to migrate compensation programs from private company to public company environments

Develop peer group of publically-traded competitive companies for use in Board and executive compensation market assessments

Assess the overall retention value of your equity programs by examining ownership levels for employees to determine if any adjustment/refresh grants should be considered prior to an IPO

Confirm if equity award eligibility will remain the same post-IPO

Develop post-IPO Board of Directors compensation program that is consistent with public company peer practices once appropriate
Administrative

Upgrade your equity management solution to accommodate public functionality (i.e. participant portal and broker and transfer agent process)

Develop SOPs for equity plan administration post-IPO
Pre-IPO: 3-6 Months Out 11

12. Pre-IPO: Approaching IPO 12
Elements
Considerations
Financial

Resolve any open accounting issues with SEC, including cheap stock

Update historical financial statements with annual and interim financial statements, as necessary

Finalize finance team for "Being Public"

Continue working on remediation of any material weaknesses, if necessary
Governance

Finalize committee

Delegate authority to officers to grant “routine” equity awards?

Implement insider trading and pre-clearance policies
Legal

Consider freezing new option grants as approach pricing

Prepare Form S-8 and stock plan prospectuses

Section 16 officer SEC ownership filings
Compensation

Assess the competitiveness of the executive compensation program against approved peer or survey companies covering salary, incentives and equity

Review cash incentive practices at peer companies and begin to explore alternatives to align your existing programs with public company market practices

Consider the additional of a Evergreen provision to the equity plan and if so at what level of annual refresh

Consider the introduction of an Employee Stock Purchase Plan (ESPP)
Administrative

Prepare for employee meetings -- insider trading, lock-up, ESPP roll-out, taxes on awards

Evaluate employee communications materials and methods (intranet)

Transition stock recordkeeping to transfer agent

13. Equity Practices Comparison / Transition Prep 13
Elements
Typical Private Philosophy
Typical Public Philosophy
Setting Award

Established based on a target ownership percentage

Equity grants are established based on a target annual grant value

Converted to a number of options/shares based on the current stock price
New-Hire vs. Ongoing/ Refresh

Large new-hire grant

Refresh grants delayed until IPO approaches, or 3-4 years after hire

Refresh guidelines set anywhere from 25% to 33% of new-hire awards

New-hire award typically 2x ongoing award size

Most employees eligible for ongoing award after one year of service
Vehicle Mix

Stock options predominantly (A few notable exceptions have used RSUs pre-IPO recently, however may require cash reserves to address employee taxes)

Mix of stock options and RSUs

Emphasis towards RSUs

Prevalent use of performance shares for executives
Participation

New hires: nearly 100%

How is grant size determined?

Refresh awards: targeted at key performers and those employees greater than 50% vested (25% to 30% of population receives)

New hires: participation decreases as company increases in size (may eliminate eligibility altogether below certain level)

Ongoing awards: Broad eligibility is maintained, although awards targeted at top performers (40% to 60% of population receiving annually)

14. Equity Plan Modifications at IPO
14
Practice at IPO
Technology
Life Sciences
New Equity Plan Adoption (% of companies)
90%
97%
Prevalence of Full Plan Evergreen (% of companies)
79%
83%
Median Evergreen Funding Rate (% of post-IPO total common)
4.0%
4.0%
Immediate Funding w/ Evergreen (% of post-IPO total common)
7.5%
6.9%
Immediate Funding w/o Evergreen (% of post-IPO total common)
10.9%
11.2%
Adoption of ESPP Offering (% of companies)
52%
53%

15. Start-Up to IPO Compensation Program Evolution
•
Company compensation programs mature as a company transitions from start-up in preparation for their public offering 15
IPO Preparation
Acquisition/ Merger Ready
Development Phase
Start-Up
Consulting to
Board of Directors
Consulting to
Management
Private + Public Survey Data
Private Survey Data
Ad-Hoc Job Pricing
Initial Benchmarking
Job Matching
Assessment of Cash and Equity Programs
Salary Structure Design
Equity Guideline Deployment
Incentive Plan Design
Executive Compensation Review
Equity Retention Analysis
Comp. Transition Strategy
Governance Review
Disclosure Prep.

16. Questions? Contact Us!
•
Christina Chiaramonte VP, Client Relations Solium Phone: 415.426.7932
christina.chiramonte@solium.com
•
Laura Lakin McDaniels Special Counsel Cooley LLP Phone: 650.843.5167
lmcdaniels@cooley.com
•
Mike Gould
Partner, Transaction Services PwC Phone: 312.298.3397
mike.gould@us.pwc.com
•Ken Wechsler Director Radford Phone: 760.633.0057
ken.wechsler@radford.com 16
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17. 17
Appendix

18. 18
Accounting and Financial Reporting

19. The Process of Going Public
Key financial information to be included in Form S1:
•
Annual and interim historical financial statements
•
Summary and selected financial information
•
Pro forma financial statements
•
MD&A
•
Executive compensation (CD&A)
•
Capitalization
•
Dilution 19

20. Going Public: Accounting & Financial Reporting
Common issues:
•
Public company GAAP and disclosures vs. private company requirements
•
3 years of audited financial information, plus 2 additional years, which may be unaudited
•
Predecessor/successor financial statements
•
Preparation of interim financial statements, and additional interim data that may be required
•
Pro forma financial statements
•
Additional audited financial statements for ‘significant’ acquired companies prior to date of acquisition
•
Tax, legal and financial reporting implications of reorganizations in advance of and IPO
•
Non-GAAP measures
•
Cheap stock
•
Segments
•
EPS 20

21. Post-IPO Historical Financial Reporting Deadlines 21
Category of filer
Form 10-K deadline
Form 10-Q deadline
Large accelerated filer
($700 million)
60 days
40 days
Accelerated filer
($75 million to $699 million)
75 days
45 days
Non-accelerated filer
(less than $75 million)
90 days
45 days

22. Being Public: Accounting & Financial Reporting
Common issues for private companies looking to become public:
•
Close cycle inadequate for public company reporting
•
Timing
•
Quality
•
Neither adequate nor documented policies and procedures
•
Lack of sophisticated budgeting and forecasting process
•
Inexperienced management and external reporting
•
Number of FTEs and inadequate skill sets within finance department
•
Lack of public company accounting and reporting expertise
•
Competing demands of resources for ‘going public’ tasks and ‘being public’ readiness
22

23. 23
Governance

24. Governance & Leadership 24
Example framework
Corporate Governance & Oversight
Policies & Procedures
Internal control
Budgeting, planning, and forecasting
Accounting policies and consolidation
Disclosure controls and procedures
HR
IT
Compliance
Internal Audit
The corporate governance structure provides the overall direction for the organization
The code of conduct provides the values that drive the development of policies and procedures
The entire framework is monitored by internal audit

25. Governance & Leadership
Requirements and considerations
•
Code of conduct/code of ethics
•
Code of conduct adopted and made publicly available for directors, officers, and employees
•
Waivers of the code for directors or executive officers be promptly disclosed
•
Issues/considerations:
◦
Global versus local policies
◦
Language
•
Whistleblower program
•
Lack of sophisticated budgeting and forecasting process
•
Procedures established for receiving, retaining, and treating alleged incidents
•
Issues/considerations:
◦
Local laws (anonymous reporting)
◦
Insource versus outsource 25

26. Governance & Leadership
Requirements and considerations (cont.)
•
Board of Directors
•
Majority independent directors (12-month phase-in for IPO companies)
•
Non-management directors required to meet in executive session
•
Annual performance evaluations of the board and board committees required
•
Issues/considerations:
◦
May need to recruit more than one new independent director
◦
Board likely to function differently with more independent directors 26

27. Governance & Leadership
Requirements and considerations (cont.)
•
Audit committee
•
Required by SEC, New York Stock Exchange (NYSE) and Nasdaq
•
At least three independent directors
•
Financially literate members (with at least one financial expert)
•
Responsible for appointing, compensating, retaining, and overseeing the work of the external auditors
•
Financial reporting process supervision
•
Compensation committee
•
Required by SEC, New York Stock Exchange (NYSE) and Nasdaq
•
Is composed entirely by independent directors
•
Responsible for determining the compensation of the Chief Executive Officer and all other executive officers of the company
•
Approve the goals and objectives of the CEO relevant to CEO compensation
•
Has the sole discretion to retain or obtain the advice of a compensation consultant, legal counsel or other adviser 27

28. Internal Controls
What does SOX mean for public entities?
•
The SOX Act legislates that companies should have internal controls in place over financial reporting and report on a quarterly basis that they are operating effectively
•Good internal controls are no longer just best practice – they are law under the Act 28

29. Internal Controls
Key Section 404 requirements
•
Section 404 requires that management has internal controls over financial reporting, which is part of an internal control framework to prevent and/or detect material misstatements to the financial statements
•
This control framework should include documentation of the controls, associated policies, and procedures that contribute to the control framework and documentation, which can be relied on as part of a validation procedure to ensure that the controls are operating as designed. (A commonly used control framework is Committee of Sponsoring Organizations [COSO] of the Treadway Commission)
•The three elements to the control framework are:
•Business process controls,
•IT controls, and
•Entity-level controls 29
*Note: EGCs filing under JOBS Act are exempt from internal controls audit required by Section 404(b)

30. Internal Controls
Key Section 302 requirements
•
The certification is intended to hold the CEO and CFO accountable for ensuring that:
•
The financial report neither contains any untrue statement of a material fact nor omits to state a material fact
•
All financial statements and information are fairly presented
•
Disclosure controls and procedures are established and maintained
•
The disclosure controls cover the whole company, including consolidated subsidiaries
•
Necessary control weaknesses have been disclosed
•
Any fraud has been disclosed
The CEO and CFO certify quarterly with every 10-K and 10-Q
30

31. Governance & Compliance Timeline: Key Milestones 31
Registration statement declared effective
Date of listing
90 days after registration
First quarter
after filing
One year after registration
One year after
listing
90 days after
listing
Second 10-K
filing
At least one independent director on:
•
AC
•
Nominating committee
•
Governance committee.
Majority independent directors on:
•
AC
Majority independent directors on:
•
Nominating committee
•
Governance committee
Section 302 filing
Fully independent directors on:
•
AC
Fully-independent directors on:
•
Nominating committee; and
•
Governance committee
Majority independent directors on:
•
Board of directors
Section 404 compliant
SOX Act of 2002 requirements
NYSE governance listing requirements
*Note: EGCs filing under JOBS Act are exempt from internal controls audit required by Section 404(b)