Going public in 2016? Plan your equity strategy early
January 04, 2016
PitchBook Dealmakers Column
Semler Brossy Consulting Group researched middle market IPOs over the last five years. Here are six general rules to keep in mind:
1. Keep the equity overhang at IPO below the high teens. If a company has dilution in the high teens at IPO, it restricts its flexibility. The research suggests an overhang of 17% or below.
2. Aim for an annual run-rate of about 1% by year three. Research suggests that the variance in run-rates narrows over time and normalizes to about 1% annually at current market valuations.
3. Grant about 20% of the available equity pool each year. Companies that retain 80% of the pool will have enough equity for eligible employees for four to five years. Think of this as an 80/20 rule to start, and tweak specific grant levels from here.
4. Expect to replenish the pool within three years of IPO. At least one-third of companies go back for more shares within four years.
5. Add performance shares within the first four years. Be sure to consider how pay will support the strategic objectives of the organization. Programs with a high degree of performance orientation take time and effort to develop.
6. Be ready with contingency plans should you encounter surprises. Be sure to have a written plan that outlines what happens if your share price plunges. Semler Brossy suggests a longer-term outlook for granting shares at low stock prices.
Lessons from the research are plain: the pay program requires diligent and early planning. This is especially true as the structure of equity-financing options continues to evolve, companies IPO later, and pay programs take into account the more stringent governance requirements.