Background. For a private company planning to execute an initial
public offering (IPO), the process provides a unique opportunity for
companies to prepare for the governance-inspired public scrutiny of
executive compensation in a publicly traded environment. Boards and
executives need to work together to focus on how to handle executive
compensation issues before they might arise. Questions that should be
considered and addressed include:
- Do the company’s compensation and business strategies align?
- Has the company developed a process for keeping the compensation
committee and board members informed about executive pay issues and
decisions?
- What does the company want to provide in the way of executive
incentives?
- What role should stock play in compensation and what is the right
amount to reserve?
- Are the company’s equity program documents flexible enough to
accommodate the changing types of equity awards (e.g. omnibus plans).
- What is the appropriate “compensation mix” for executives?
- How much compensation should be provided (especially given public
disclosure)?
- What performance measures are most appropriate for the annual and
long-term plans, and how should these plans be structured?
- If employment agreements are in place to protect the executives’
compensation in the event of termination without cause or in the event
of a change of control, has the committee reviewed the amounts payable?
It used to be that every start-up company, be it in the biotech industry,
software industry, or any other, took every conceivable step recommended by
smart lawyers and venture capitalists to position themselves so that they
were ready to go public, should the moons all align. These measures included
having clean stock ledgers that added up to the correct number of shares
outstanding, experienced management, appropriate compensation arrangements
for founders and management, adequate stock plans for employees and
directors, solid patent portfolios, copyrights and/or trade secrets, a good
balance sheet, quality investors, outstanding board members, well-known
scientific advisers……and so on. All of which leads up to the “holy grail”
exit strategy of an initial public offering.
Today’s Atmosphere. Due to the passage of the Sarbanes-Oxley Act, an
IPO may not be the holy grail exit strategy after all. Given today’s
“inquisition-like” atmosphere that seems to pervade the public markets,
founders and investors alike are seriously questioning the wisdom of
becoming a public reporting company. Indeed, many publicly held companies
(including some Penicle Group clients) are considering going private
The stakes have been raised in the public marketplace and those who
choose to play had better be prepared to undergo extensive scrutiny and
increased exposure. The legislation and regulations continue unabated with
new material coming out frequently. The principal exchanges (New York
Exchange and Nasdaq) continue to adopt new sets of rules and regulations.
The NYSC now requires that its members provide performance appraisals
on company executives, proxy rules concerning executive compensation plans
have been broadened to include specific pay strategy descriptions and logic,
and some publicly traded companies are allowing shareholders to cast their
“non-binding” assessment ratings regarding the appropriateness of executive
remuneration.
Sarbanes-Oxley. Arising out of the Enron debacle, Sarbanes-Oxley
imposes the following obligations, risks, liabilities, or just plain
complications for founders, entrepreneurs, board members, and investors
desiring to take a company public:
- Certification of financial statements by the chief executive officer
and chief financial officer (with resulting potential personal liability
including both civil liability and harsh criminal penalties).
- Special reporting obligations for non-GAAP (generally
accepted accounting principles) financial information, many of which
have been accepted in the investment world for years, such as EBITDA
(earnings before interest, taxes, depreciation and amortization).
- Special requirements for having independent directors on the board
and audit committee.
- Almost immediate filing of reports of insider sales and purchases of
company shares with public flailing for those who miss the two-day
window.
- New protections for “whistleblowers” that provide both civil and
criminal penalties for officers who violate those provisions by
“retaliating” against the whistleblower.
- Requirement to formalize disclosure controls and procedures.
- Formal code of ethics requirement.
- Complete prohibition of all loans to officers and directors
including such detail as “cashless exercise” of options and advancing of
expenses.
Only a securities expert is really qualified to be able to read and
decipher all the impositions disseminated by politicians in Washington, all
trying to outdo each other in their own quest to protect the public from
supposedly greedy corporate executives.
Again, Are you ready? Are you sure?
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