Connell & Partners 2013 Executive Compensation in Recent IPO Study By Jack Connell, Kim Glass and David Schmidt

Transcription

1 Connell & Partners 2013 Executive Compensation in Recent IPO Study By Jack Connell, Kim Glass and David Schmidt Executive Summary The transition from pre-ipo to a publicly traded company is significant in many areas, including executive compensation levels and practices. Some of the major areas that change include: Cash Compensation Cash compensation levels increase for all executives, particularly for the CEO and CFO. Cash compensation levels increase for all executives, particularly for the CEO and CFO. This is usually because companies try to rebalance their total compensation offering and shift from a heavier reliance on equity to a balanced approach of short- and longterm incentives. With their newly procured cash, there is less of the need for employees to defer their compensation into equity holdings. Furthermore, the additional risk, exposure, shareholder commitments, and management of Wall Street expectations, is a significant increase in executive responsibility, and the pay levels reflect that. Cash compensation levels increase upon IPO for all executives, particularly for the CEO and CFO. Increased amounts are generally in the double digits for key executives such as the CEO, CFO and Head of Sales. 36

2 Focus of Study Our study is comprised of 46 companies in the high technology, biotechnology and alternative energy arena that went public in the year 2011 and have since released proxy data for that year. We looked at the compensation levels and practices in the year prior to their IPO, and in the year of their IPO to examine the changes. We examined the CEO, CFO and Head of Sales Positions as these were the three most prevalent positions listed. Other roles did not have enough data points to be statistically significant. We only used incumbents who were in their roles for the two-year timeframe. Increase Amounts Increased amounts are generally in the double digits for key executives such as the CEO, CFO and Head of Sales. CEO The median increase for a CEO s base salary was 14%, and the mean 21%. The target bonus opportunity as a percentage of base salary had a median increase of 12%, and a mean increase of 16%. (Note: This is an increase in the percentage of base salary. For example, an increase from 25% of base to 75% would be an increase of 200%, not 50%. The math of each is as follows the correct calculation is (75-25=50 then (50/25)*100=200% and not just 75-25=50 which is just the delta in the percentages.) The increase in CEO target total cash compensation was 21% at the median and our group had a mean increase of 36%. This number reflects the distribution of the change in target total cash among companies that reported target bonus figures for both the year of IPO and the year prior. CFO CFO target total cash compensation increased 16% at the median with a mean of 20%. Base salaries had median and mean increases of 5% and 9%, respectively, and target bonuses had increases of 6% and 11% at the median and mean, respectively. Head of Sales Head of Sales compensation (actually the #2 most highly paid executive at the median vs. the typical CFO or COO role in larger public companies) target total cash compensation increased 9% at the median with a mean of 16%. Base salaries had median and mean increases of 3% and 6%, respectively, and target bonuses had increases of 8% and 16% at the median and mean, respectively. Bonus Targets Bonus targets increase and bonus plans shift from primarily discretionary to more formulaic and goal based. This is because sustained growth in traditional metrics such as revenue and income (and often earnings per share or EPS) becomes more expected. Public companies also tend to have greater ability and resources to forecast future performance, thus a more formulaic approach to compensation becomes a viable option once public. Share Usage and Dilution Equity dilution and the annual stock burn rate increases as the IPO approaches. Equity dilution and the annual stock burn rate for executive and employee stock plans, which were significant early on in pre-ipo firms, temper as the company approaches later stages prior to the IPO. Burn rate then increases again as the firm approaches and completes the IPO due to refresh grants to enhance retention for executives and key employees, and ESPP s are implemented. Once in a public company environment, dilution and overhang need to be managed relative to institutional investor expectations. Evergreen stock plan replenishment is often highly recommended, as it will provide the share pool with flexibility to make on-going grants to new critical employees, and pre-public is the only time a company can implement such a plan feature. It is critical to ask for a large enough evergreen (typically 4-5%/year in the industries we studied,) to fund the stock needed per year. This does not mean you have to use this amount every year as it can be banked for future years. Bonus Targets Bonus targets increase and bonus plans shift from primarily discretionary to more formulaic and goal based. 37

3 Share Usage and Dilution Equity dilution and the annual stock burn rate increases as the IPO approaches. Equity Vehicles Options continue to remain the primary vehicle of choice for pre-ipo/ipo firms. In the first years after IPO (often 2-3 years out), companies begin to shift away from relying solely on stock options to incorporating other stock based vehicles, such as full-value shares. Restricted stock awards or restricted stock units help to manage stock dilution, provide downside protection in the event of moderate to flat growth post-ipo, and provide increased retention potential. Performance-based awards are still a significant minority of shares used, or not used at all, as companies often have limited performance history to predict multi-year performance necessary for implementing these plans. Security Provisions Severance and Changein-Control protection helps to provide added security for the employee and ensure business continuity for the company due to the heightened risk of an IPO. Because of the increased risk of IPO failure and heightened potential for takeover in the first years of being a public company, companies will often provide enhanced security through severance and changein-control (CIC) arrangements (although still below those in the level of more mature public companies). Given the current governance environment, they usually lack the so-called egregious or problematic provisions such as single triggers and golden parachute gross ups (IRC SS. 280(g) AND 4999) that were prevalent many years ago. There is generally some (most common practice is 100% though a few companies have less) acceleration of equity vesting upon a double-trigger (CIC and loss of employment) severance. Severance and CIC levels for freshly public firms are still low when compared to the broader public company environment of 2-3X for the CEO and 1-2X for his/her direct reports. Stock Ownership Guidelines Formal Stock Ownership Guidelines are a minority practice. Only two of the companies in the sample implemented executive stock ownership guidelines. This differs greatly from most mature public companies who have implemented them, as stock ownership guidelines have evolved into a corporate governance best practice. Companies at such a young stage likely do not feel the need to implement them as most key executives are holding large quantities of stock and are subject to post-ipo lock ups, typically delaying insider sales for up to six months post-ipo, and are therefore appropriately aligned with shareholder interests. Thus, companies typically will wait several years before implementing formal guidelines. Given some of the poor stock price performance of recent IPOs, however, we may begin to see more of a focus on ownership guidelines in the future, as Boards and shareholders look for additional tools to ensure executives remain focused like owners and are aligned with shareholder interests. Equity Vehicles Options continue to remain the primary vehicle of choice for pre-ipo/ipo firms. 38

4 Compensation Levels CEO and CFO Pay Increases with Additional Responsibilities. CEO and CFO compensation changed the most dramatically in the year of IPO, likely in response to the significant changes to their roles. Out of all the public company officers, these two roles often have the biggest increase in risk since they now have to sign off on the financial statements under Sarbanes-Oxley, and they also have the additional responsibilities of working with Wall Street and the investment community to generate continuing interest in the company. Compensation also increases as the companies no longer, in general, have the cash burn constraints that they had as private, venture-backed organizations, and therefore can take a more reasonable and balanced approach to total compensation by shifting compensation into cash instead of relying on mostly equity. Why do we Illustrate Multiple Compensation Changes? You will notice that when we talk about the various changes in compensation, we first present the median and mean increase in various compensation elements. It is important to differentiate these increases from the differences in the median or the mean summary statistics for each year of data. For the increase amounts, we took the difference between the two years of data examined for each individual executive, then presented the median (50th percentile) and mean (arithmetic average) of the data set of those changes. Now, why do we do this? We feel this is the best way to illustrate how compensation philosophies can adjust with an IPO, because this group was crafted without respect to size of the company. On base salary for example, this methodology helps a firm anticipate what a typical base salary increase might look like in the year of IPO. 39

5 Chief Executive Officer (CEO) Compensation Changes (Pre- and Post-IPO) The median change in base salary for a CEO from pre-ipo to the year of IPO the year of IPO was 14% and the mean was 21%. The median change of our sample went from $307K to $383K, or an increase of 25%. For companies that reported annual bonus targets in both years, the median increase in target Total Cash Compensation was 21% and the mean was 36%. Total Cash Compensation reflects base salary+annual target bonus. Some of the bigger names in IPOs also had some of the most drastic changes to their CEOs pay. LinkedIn doubled their CEO s cash compensation, with base salary going from $250K to $480K per year, and target total cash from $400K to $818K. On the other hand, Groupon CEO Andrew Mason had his base salary shifted, at his request, from $180,000 to $ Changes in Cash Compensation with IPO 25th Percentile 50th Percentile 75 Percentile Mean Base Salary Change (%) 3% 14% 28% 21% Target Bonus Change (% points of base) 0% 12% 34% 16% Target Total Compensation Change ($K) 7% 21% 67% 36% Executives for which target bonus was not available were not figured into target total cash compensation. Fiscal Year Before IPO 25th Percentile 50th Percentile 75 Percentile Base Salary ($K) $282.2 $307.4 $382.0 Target Bonus (as % of Base) 35% 50% 80% Target Total Compensation ($K) $404.3 $482.5 $664.2 Executives for which target bonus was not available were not figured into target total cash compensation. Year of IPO 25th Percentile 50th Percentile 75 Percentile Base Salary ($K) $318.1 $382.5 $450.0 Target Bonus (as % of Base) 46% 67% 100% Target Total Compensation ($K) $482.5 $727.5 $834.0 Executives for which target bonus was not available were not figured into target total cash compensation. When possible, executive s post-ipo cash compensation is used. 40

6 Chief Financial Officer (CFO) Compensation Changes (Pre- and Post-IPO) The median of the changes in base salary for the CFO was 5% and the mean was 9%, with increasing base salaries from $250K to $285K, or a change at the median of 12%. Annual target bonuses had a mean increase of 11% and target total cash compensation had a mean increase of 20%. Also, there was a slight increase in the premium the CEO receives relative to the CFO over the time period examined. The average premium for target total cash went from 54% in the year prior to IPO to 65% in the year of IPO. This is likely due to market pressures for the CEO role, versus a prior focus of more internal equity between executives while still private/ VC-backed. Also, the CEO might delay an increase in cash compensation while guiding what is often his or her company towards IPO, while CFOs are often brought in and expect to be compensated closer to the market rate from the outset. Changes in Cash Compensation with IPO 25th Percentile 50th Percentile 75 Percentile Mean Base Salary Change (%) 2% 5% 13% 9% Target Bonus Change (% points of base) 1% 6% 16% 11% Target Total Compensation Change ($K) 7% 16% 33% 20% Executives for which target bonus was not available were not figured into target total cash compensation. Fiscal Year Before IPO 25th Percentile 50th Percentile 75 Percentile Base Salary ($K) $221.3 $250.0 $290.0 Target Bonus (as % of Base) 25% 38% 50% Target Total Compensation ($K) $302.8 $355.0 $386.5 Executives for which target bonus was not available were not figured into target total cash compensation. Year of IPO 25th Percentile 50th Percentile 75 Percentile Base Salary ($K) $250.0 $286.0 $309.0 Target Bonus (as % of Base) 30% 50% 60% Target Total Compensation ($K) $336.5 $435.0 $500.8 Executives for which target bonus was not available were not figured into target total cash compensation. When possible, executive s post-ipo cash compensation is used. 41

7 Head of Sales (HOS) The median of the increases in base salary for the HOS was 3% and the mean at 6%. Annual target bonuses had a mean increase of 16% and target total cash compensation also had a mean increase of 16%. This is actually the #2 position in terms of total target compensation; however, it is a small sample size of 12 and is due primarily to the high targeted bonuses of nearly 100%, showing the importance of meeting revenue targets once a company goes public. This targeted compensation is generally earned in the form of commission, which is paid only if sales or margin targets are met unlike the corporate plans that the CEO and CFO are likely on. Changes in Cash Compensation with IPO 25th Percentile 50th Percentile 75 Percentile Mean Base Salary Change (%) 1% 3% 7% 6% Target Bonus Change (% points of base) 3% 8% 26% 16% Target Total Compensation Change ($K) 5% 9% 27% 16% Executives for which target bonus was not available were not figured into target total cash compensation. Fiscal Year Before IPO 25th Percentile 50th Percentile 75 Percentile Base Salary ($K) $202.8 $225.5 $235.0 Target Bonus (as % of Base) 28% 70% 119% Target Total Compensation ($K) $283.6 $331.3 $445.0 Executives for which target bonus was not available were not figured into target total cash compensation. Year of IPO 25th Percentile 50th Percentile 75 Percentile Base Salary ($K) $208.6 $228.0 $249.0 Target Bonus (as % of Base) 350% 98% 117% Target Total Compensation ($K) $350.3 $450.0 $498.5 Executives for which target bonus was not available were not figured into target total cash compensation. When possible, executive s post-ipo cash compensation is used. 42

8 Share Usage and Dilution Companies Refresh or Revamp Equity Incentive Plans Pre-IPO An important step before completing an IPO is to approve a new stock plan and share reserve, as previous methods of distributing shares to employees will likely have been exhausted or close to it. Furthermore, it is much more efficient to get plans with the needed flexible provisions, such as annual replenishment features (or Evergreens), approved in a private company environment than with public shareholder scrutiny. The graph below illustrates the equity outstanding, shares available for grant, and the total equity overhang percentiles for the study group pre-and post-ipo. We examined these figures from each company s prospectus filing and separated out the new equity plans where possible. Many companies will approve the stock plan before the IPO and wait to implement it concurrently with the offering. Others will start using it before the offering. Equity Outstanding The sum of stock options outstanding and unvested restricted shares outstanding as a percentage of shares outstanding. Total Overhang The sum of equity outstanding and shares reserved for issuance. Equity Overhang 35% 30% Pre-IPO Post-IPO 26.1% 29.6% 32.7% 35% 30% 25% 22.5% 23.3% 21.6% 25% 20% 17.6% 16.9% 16.6% 20% 15% 13.5% 13.8% 13.0% 15% 10% 9.0% 6.2% 8.3% 10% 5% 0% PG... PG... PG % 1.7% 0.7% PG... PG... PG... PG... PG... PG... 5% 0% Equity Outstanding Shares Available for Grant Total Overhang Approval of the new share plan outweighs the incremental dilution caused by the share offering leading to increases in total overhang. Evergreen provisions provide for the automatic annual replenishment of a stock plan s share reserve by a set amount of shares, a percentage of shares outstanding, or more often, the lesser of the two. These have become increasingly popular, with a vast majority of companies in the study enacting them pre-ipo. Many companies have implemented Evergreens as a part of their Employee Stock Purchase Plans (ESPPs) as well. 43

9 The following charts display the breakdown of Evergreens for stock plans and ESPPs according to the percentage of shares outstanding providing for in the plans. Equity Plan Evergreen Percentages 4.5% 7% 5.0% 28% 4.0% 28% ESPP Evergreen Percentages No Evergreen 25% 3.5% 5% 3.0% 5% 3.9% 2% We have long recommended between 4% and 5% of shares outstanding for stock plan Evergreens, and the data shows this continuing to be the trend. 1% of shares outstanding is the most popular amount for an ESPP evergreen. Pre-IPO and IPO Equity Grants Remain a Prevalent Practice, with Options Continuing to be the Vehicle of Choice Grants of any type of equity vehicle (stock option, restricted stock award/unit, performance share) were awarded by approximately 75% of companies in the year prior to IPO and nearly 90% of companies in the year of IPO, indicating that companies are likely reloading executives and key employees prior to the IPO. Many of them are presumably nearly or fully vested with very low strike prices given the length of time that it is taking companies to go public these days. Gone are the days of the initial/new hire grant prior to IPO and then no further grants until post-ipo, which was very prevalent in the dot.com boom of the late 90 s. 0.50% 2% 1% 23% ESPP w/o Evergreen 12% 2%+ 7% No ESPP 56% Approximately 70% of the companies granted stock options in the year prior to IPO and slightly over 75% in the year of IPO. Stock grants (either restricted stock awards or restricted stock units (RSUs)) were granted by approximately 15% of companies in the year prior to IPO and nearly 30% in the year of IPO. Finally, performance awards (either grant or vesting contingent on performance hurdles being met) comprised less than 10% of companies each year, likely due to the fact that for companies in this stage of growth, it is very difficult to predict and forecast multi-year performance. 44

10 LTI Design Vehicles Stock Options Remain the Most Prevalent Choice of Equity Vehicles Stock Options are still far and away the vehicle of choice for new IPO s. In the year of IPO, 76% of the participants in the survey granted stock options, while 28% granted RSU s. This is not surprising given the strong alignment between pay and performance and the direct connection options create between employees and shareholders. Moreover, they are an effective way to reward employees in a start up environment for their significant hard work and sacrifices prior to the IPO. Additionally, as small, early-growth stage companies they generally have a larger allowable burnrate by institutional investors, and/or they adopted an Evergreen element to their plan while still private so they do not have the burn-rate constraints that many larger public companies have and thus are forced to use restricted stock units to manage their share pools more conservatively. Additionally, they often do not have the executive/key employee retention concerns that larger companies with flat share prices may have; again alleviating the need to deliver RSU s to increase retention value. Only one recent public company offered performance-based LTI as most likely cannot forecast multi-year financials accurately enough to make them a feasible alternative. The previous LTI usage chart is for all Top 5 reported officers (not the entire employee population, which likely differs, as this is not disclosed) in the S-1 filings who were in place in their respective companies for both years (year of IPO and prior year). This is likely more illustrative initially than showing a position-byposition look, which we will look at after this analysis as there are some intriguing differences. NEO LTI Instrument Usage 100% 80% 60% 40% 20% 0% Options Stock Performance Any Instrument Prior Year IPO Year CEO LTI Instrument Usage This LTI usage chart is for the CEO who was in place in their respective company for both year of IPO and the year prior to IPO. 46% of the CEOs were granted stock options in the year prior to IPO and approximately 65% in the year of IPO. Stock grants (either restricted stock awards or restricted stock units (RSUs)) were granted by approximately 15% of companies in the year prior to IPO and fell slightly too approximately 13% of companies in the year of IPO. Finally, performance awards (either grant or vesting contingent on performance hurdles being met) were granted by 7% and 2% of companies each year, respectively, likely due to the fact that for companies in this stage of growth, it is very difficult to predict or forecast multi-year performance. Grants of any type were made by 59% of companies in the year prior to IPO and 72% in the year of IPO. These figures are all lower than the Top 5 reported officers, likely because the CEO has the highest total shares held as a percentage of shares outstanding and thus is least likely to need any refresher shares. CEO LTI Instrument Usage 100% 80% 60% 40% 20% 0% Options Stock Performance Any Instrument CFO LTI Instrument Usage Prior Year IPO Year 54% of the CEO s were granted stock options in the year prior to IPO and in the year of IPO. Stock grants (either restricted stock awards or restricted stock units (RSUs)) were granted by 7% in the year prior to IPO and rose significantly to 15% in the year of IPO (likely to insure retention of the CFO and to reflect the significant increase in responsibilities for this position). Finally, performance awards (either grant or vesting contingent on performance hurdles being met) were granted by 4% of companies each year, likely due to the fact that for companies in this stage of growth, it is very difficult to predict multi-year performance. Grants of any equity type were made by 61% and 60% of companies, 45

11 respectively, in the year prior to IPO and in the year of IPO. This is likely low due to the fact that most VC/ PE-backed companies do not hire a CFO to take the company public until a couple of years before the IPO, thus there is no need to refresh the shares. CFO LTI Instrument Usage 80% 60% 40% 20% 0% Options Stock Performance Any Instrument Stock Ownership Guidelines While Equity Grants are Prevalent, Formal Ownership Guidelines are Not. Only 2 of the companies in the sample implemented executive stock ownership guidelines. This differs greatly from most mature public companies who have implemented them, as it has evolved as a corporate governance best practice. They likely do not feel the need at such a young stage as most key executives are holding large quantities of stock and are subject to post IPO lock ups preventing insider sales for up to six months post- IPO. Thus, companies typically will wait several years before implementing them. Given some of the poor stock price performance of recent IPOs, however, we may begin to see more of a focus on ownership guidelines in the future, as Boards and shareholders look for tools to ensure executives remain focused like owners and aligned with shareholder interests. Other Plan Design Features Annual Bonus Plan Design Most Bonus Plans Remain Discretionary Prior Year IPO Year Of the 46 annual bonus plans, 17 (37%) were formula based, 27 (59%) were discretionary and 2 (4%) had no formal plans. Revenue (in 20% of companies) and profitability (net income, EBITDA, etc.), used in 16% of companies, were the most prevalent metrics listed in the Companies Compensation Discussion &Analysis (CD&A) sections of the Proxy. This is not surprising given that these are typically the two biggest drivers of value creation and expectations by Wall Street of a new public company. Employee Stock Purchase Plan (ESPP) ESPPs Remain a Critical Mechanism for Encouraging Employee Ownership 40% of the recent IPO s implemented an ESPP upon IPO. Of those that did, roughly 50% implemented an evergreen feature in the plan with a median replenishment of 1% of shares outstanding added to the plan every year. All (100%) also had a look-back feature, with an average look-back of 6 months, allowing participants to purchase their company s stock at a 15% discount, making these plans a very attractive benefit for the broad-based population. The majority of larger public technology and life science firms have an ESPP, so this is an area of significant difference between the two types of firms. We suspect that this is due to the notion that IPO companies typically grant equity more broadly than their more mature counterparts, and therefore, already have broader ownership levels. Severance/CIC 65% of companies in the study offered severance benefits for executives without a change-in-control (CEO and CFO), whereas 82% (CEO and CFO) of companies offered severance benefits to executives with a change-in-control. The median cash payment to a CEO upon a separation without a CIC was 6 months of salary, including non-receiving. The median was 12 months for those receiving. For a separation with a CIC (all doubletrigger), the median was 12 months, including nonreceiving and the mean for those receiving was 12 months. For the CFO, the median without a CIC was 6 months, including 0 s and 12 months for those receiving. Compensation Committee Checklist for Pre-IPO Companies The compensation changes outlined in this white paper are only a fraction of what the Compensation Committee must address as it prepares for an IPO. Here below are additional topical areas the Compensation Committee should be thinking about as a firm is contemplating going public in the near future. If companies can address these issues as early in the run up prior to the IPO as they can, they will be rewarded with more flexibility on share usage, compensation expense forecasting, disclosure, and potential for increased performance to help drive the business strategy. They will also have a more strongly written CD&A, with fewer comments, that need to be responded to, by the SEC. 46

12 Overall Determine roles and decision rights of employees (HR, Finance) and consultants in developing executive compensation programs. Assess current compensation consultant, including independence and potential conflicts of interest. If you do no not currently have a consultant, hire one before the IPO. If you do, assess current consultant and select for next year ensuring the firm is as strong in a public company environment as it is in a VC-Backed environment. Develop an executive compensation philosophy (including program objectives, pay positioning, mix, types of vehicles, etc). Develop a defensible Peer Group of comparable public companies. Review competitiveness of executive compensation. Set competitive compensation levels (base, target bonus, equity/long-term incentive awards, perquisites/benefits and total direct compensation). Short-Term Incentive/Bonus Plans Determine overall strategy and framework (e.g., financial goals, milestones, discretionary, frequency). Select financial performance measures and individual / MBO goals. Calibrate financial performance targets versus market/street expectations, internal budget, and Peer Group performance. Develop formalized Short-Term Incentive Plan document. Long-Term Incentive Review / develop a long-term incentive strategy including appropriate instrument use / mix. Develop an LTI award matrix with values and participation rates for all employee levels. Determine if an Evergreen provision will be used. If so, determine appropriate evergreen size. Set equity utilization (share run rate) budget for coming fiscal year. Determine if any IPO awards will be made to top executives and key employees. This will be key to do if most or all of current awards are fully vested as the company thus has little or no retention capability. Discuss and potentially implement executive and Board share holding/ownership requirements. Employment, Severance, and Change-in-Control (CIC) Arrangements Review existing employment, severance, and CIC agreement terms and conditions and potential payouts. Complete a competitive analysis of key terms for employment, severance, and CIC agreements and set terms going forward based on the market and overall pay philosophy. Ensure all egregious pay provisions are removed from any existing agreements or a commitment is made in the CD&A to grandfather in existing executives but not have any egregious provisions in any new agreements going forward. Governance Develop or amend (as needed) Compensation Committee charter. Draft Compensation Discussion & Analysis (CD&A) and accompanying tables for S-1 and Proxy. Compensation risk assessment. Review and set Board of Directors compensation for the following year. Set equity award approval process, including what authority, if any, will be delegated to management. Formalize policy regarding award grant timing. 47

13 Best Practices for Companies Preparing to IPO In working with many Compensation Committees for firms that are going to IPO, we consider these to be best practices in the marketplace: Compensation Committee selects and has an independent executive compensation consulting firm work for it a firm that does no other work for the management of the company and whose consultants have no personal (e.g., non-business ) relationships with the Board. A named Peer Group of public company comparables (for executive compensation purposes) exists that is similar in terms of industry, revenues and market capitalization so the executive compensation decisions are reasonable, appropriate and defensible (if challenged by institutional investor advocacy groups). Ideally firms Company at or near the median of proposed group of companies in terms of both revenues and market capitalization. Executive compensation levels are within market norms (defined as 25th to 75th percentile of the Peer Group and any surveys that are used). Longer-term, CEO pay levels need to be supported by company performance, most notably TSR. The company should adopt an Evergreen provision in its Equity plan pre-ipo which will be the only time that this is feasible. Ensure evergreen is large enough to support annual ongoing equity grants and any M&A activity that may occur typically in the 4-5% range for human capital intensive firms such as high-technology, biotechnology and alternative energy firms. Having a 4-5% pool become available every year does not mean the firm has to use all of those shares they simply become available for grant and may be banked for future use. Implementing too small of an evergreen will cause it to have to be discarded, as it is seen as an egregious compensation practice for mature companies by Institutional Shareholder Services (ISS) who would vote no on any stock request with such a provision. Market (Peer Group) median annual burn rates and dilution levels will have to be achieved over time (the numbers fall as the Company gets larger/more mature). 48

14 Remove any egregious executive compensation practices so that they are not red flags to ISS and similar advisory firms providing counsel to Institutional shareholders: No gross-up provisions in severance/change-incontrol arrangements. Double (i.e., CIC and termination/material change in employment relationship) versus single trigger change-in-control arrangements. Excessive executive benefits and perquisites (not typically found in firms that are going to IPO). Were typical in larger public companies. Firm is prepared for a Say-on-Pay vote after being a public company. Conduct a compensation risk assessment and include the results in the CD&A. Ensure key management and other employees are locked in for the foreseeable future through equity refresh grants prior to/concurrent with the IPO, as the time to IPO/exit has extended and that may mean that many people are or are near fully vested upon IPO and therefore there is no retention capability. The best way to look at this is through a carried interest analysis that looks at in the money value of awards not vested under various stock price scenarios. Have a succession plan in place for the CEO so management continuity is ensured should something unfortunate happen to him/her. This is becoming a market governance best practice, plus it is far cheaper and less dilutive to shareholders to promote from within that to recruit a new CEO. About the Authors Jack Connell was the founder and Chief Executive Officer of DolmatConnell & Partners and is now the Managing Director of Connell & Partners, a division of Gallagher Benefits Services, itself a division of Arthur J. Gallagher (NYSE:AJG). Jack is a nationally recognized expert in executive compensation, short-term and long-term incentive plan design linking pay and company performance, and executive reward strategy development. He works with organizations ranging from start-ups to Fortune 50 companies. He focuses on industries with intensive human-capital needs, including high technology, life sciences, and alternative energy/clean technology. He earned a Bachelor s Degree in Economics from the University of Michigan and an MBA in Organizational Behavior and Corporate Strategy from the University of Michigan Ross Graduate School of Business. Kim Glass is Principal at James F. Reda & Associates a division of Gallagher Benefits Services, in Atlanta, Georgia, and has over 15 years of experience in the executive compensation field. Kim works closely with compensation committees and/or management of public and private companies. She consults in all areas of executive compensation, including competitive benchmarking, incentive program design (cash and equity), compensation disclosure (including issues related to the CD&A and required tables), outside director compensation strategy and design, change-in-control and general severance design, and Board and Compensation Committee governance. Kim graduated from the University of Virginia and started her career as a C.P.A. at Arthur Andersen & Co. Dave Schmidt is a Senior Consultant at James F. Reda & Associates, a division of Gallagher Benefits Services, and has over twenty years of experience and functional expertise in economics, sales management, and customer research. Dave is an expert in the valuation of stock-based compensation arrangements, the review of senior executive compensation packages, modeling for FAS 123R purposes, and the design of special situation incentives and change-in-control programs. Dave earned a B.S. in Mathematics and an M.A. in Economics from Western Illinois University. 49