Alternate Realities: Equity Authorizations Before and After an IPO

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1 Alternate Realities: Equity Authorizations Before and After an IPO John Borneman Principal, Semler Brossy Greg Arnold Senior Consultant, Semler Brossy

2 Session Objectives The critical differences between equity plans pre-ipo and post-ipo What you need to know when preparing for an IPO Key considerations for equity plan authorizations as a public company

3 Agenda The world before an IPO The world after going public What you need to do to prepare Important Equity Plan considerations

4 In the beginning One equity pool Front-loaded grants Stock option focused, with performance-based vesting

5 Pre-IPO equity authorizations 12% 10% 8% 6% 9.7% 9.2% 4% 2% 0% Small Co. (<$1 billion in sales) Large Co. ($1 $10 billion in sales)

6 Pre-IPO equity authorizations 35% 30% % of Equity Outstanding Pre IPO recent examples 31% 25% 20% 15% 10% 5% 0% 22% 24% 24% 16% 16% 6% 7% 7% 8% 10% 10% 11% 12% 12% 0% 0% 1% 1% 2% 3% 3% TUMI KMI LPI BKU TMS CHEF SLCA NLSN TRGP GMED REGI AL SWFT GNC THR LPLA GSE LOCK BAH SCTY P RH

7 Pre-IPO Plan Design 1/3 Time- Based Options 1/3 EBITDA Options 1/3 Investor Return Options Year 1 Year 2 Year 3 Year 4 Year 5 20% 20% 20% 20% 20% Time based Options $70 $85 $100 $115 $130 EBITDA must be above goal before vesting, with catch up provisions 25%/ 25%IRR 25%IRR 50%IRR 50%IRR 50%IRR Eligible to vest only of return on investment >25% and >50%, with catch up provisions

8 Pre-IPO Issues Eligibility limitations Missed performance goals Delayed liquidity Not enough shares

9 Post-IPO More complex equity plan designs Need to regularly refresh authorizations Broadly distributed group of shareholders More oversight and more permission needed Additional regulatory and tax considerations

10 Multiple vehicles Vehicle Prevalence 80% 73% 76% 70% 60% 50% 49% 42% 61% 51% 40% 30% 20% 10% 0% Source: Equilar Options RSUs PSUs Options RSUs PSUs

11 and annual awards % of Equity Granted Annually Utilities Technology Services Industrials Healthcare Financial Consumer Goods Basic Materials S&P % 2.0% 1.4% 1.3% 1.4% 1.3% 1.7% 2.4% 3.1% 0% 1% 1% 2% 2% 3% 3% 4% Source: Equilar

12 More frequent share authorizations Frequency of Share Authorizations (Years) Generally every 2-4 years Some companies renew annually 15th %ile 20th %ile 25th %ile 30th %ile 35th %ile 40th %ile 45th %ile 50th %ile 55th %ile 60th %ile 65th %ile 70th %ile 75th %ile 80th %ile 85th %ile Years Between Share Authorizations Source: ISS database; Russell 3000 companies

13 Key considerations when sizing the pool Expected run-rate Timeframe Grant vehicles Share ratios/sub-limits Share counting practices

14 Many different investors many different needs Mutual Funds Private Pension Plans Public Pension Plans Hedge Funds Endowments Sovereign Wealth Funds Insurance Companies Top U.S. Money Managers Assets Under Management - $millions BlackRock $3,762,500 2 State Street Global Advisors $2,086,198 3 Allianz Asset Mgmt $2,078,015 4 Vanguard Group $1,844,998 5 Fidelity Investments $1,591,993 6 AXA Group $1,566,000 7 J.P. Morgan Asset Mgmt $1,426,402 8 BNY Mellon Investment Mgmt $1,354,648 9 Capital Group Cos. $1,130, Prudential Financial $847, Goldman Sachs Group $803, Franklin Templeton In $781, Wellington Mgmt Co. $757, Northern Trust $736, Bank of America Global Wealth $698, Invesco $687, Legg Mason $647, T. Rowe Price Group $576, Wells Fargo & Co. $537, TIAA-CREF $524,232

15 ISS and other influencers Proxy Advisors ISS: Shareholder Value Transfer Test Burn-rate Cap by Industry Glass Lewis: variety of quantitative tests Institutional Investors Fidelity: total dilution limit by market cap Others with specialized policies

16 Frequency of Failures and Impact of ISS Most companies go forward with plan that will pass <1% of share authorizations fail to receive majority support ISS recommends against ~20% of share authorizations Source: ISS database; Russell 3000 companies

17 Preparing for an IPO Critical to Have Reserve a pool of equity available to grant for incentives post IPO Determine if staking equity awards are needed concurrent with IPO Develop legal plan documents (equity incentive plan) Prepare compensation disclosures for S 1 Good to Have Competitive benchmarks of pay practices relative to market A clearly articulated compensation philosophy as a public company Adjustments to pay levels (salaries, annual incentive targets, etc.) to be consistent with public market practices Post IPO board of directors pay Not Critical Pre IPO Complete post IPO equity incentive plan strategy and design Fully designed annual incentive plan Established governance practices (e.g., clawback policies, ownership guidelines, etc.)

18 IPO Related Exemptions 162(m) Transition Rules 162(m) does not apply to compensation paid under a plan that existed while a company was not publicly held Good until the first shareholders meeting to elect directors that occurs after the third calendar year following the year of the IPO (i.e., up to four years) Applies to options, SARs or restricted stock awards only, not Performance Shares, RSUs or Phantom Equity unless vested during the transition period Emerging Growth Company Exemptions Exempt from Say on Pay and the (new) Pay Ratio disclosure rules More limited small filer disclosures For up to five years or until the company has annual gross revenue of more than $1 billion

19 IPO related equity authorizations 40% 35% 30% 25% 20% 15% 10% 5% 0% 2% 3% KMI TMS 8% 8% 4% 4% 6% 10% 8% 4% 5% 7% 8% LPI % of Equity Outstanding and Authorized at IPO recent examples IPO Share Reserve 6% 10% BKU NLSN SWFT SLCA TUMI CHEF GMED AL TRGP REGI 14% 11%14% 8% 10% GNC THR GSE LOCK LPLA 11% 8%12% BAH P SCTY 10% RH

20 Plan Design Just Because You Can Doesn t Mean You Should Excessive authorization Restricted share sub-limits/fungible ratio Individual grant limits Evergreen plan Automatic reloads Repricing Minimum vesting Generous share counting

21 Questions

22 Contacts John Borneman Principal Semler Brossy Consulting Group Greg Arnold Senior Consultant Semler Brossy Consulting Group