Introduction
As private companies grow, one of the biggest questions leaders are likely to face is, ‘What is your exit strategy?’ While there are different types of liquidity events available to companies, such as Mergers and Acquisitions (M&A), one of the most discussed is the elusive Initial Public Offering (IPO).
To the general public, a company IPO starts with the ringing of the bell signalling the start of trading, but behind the scenes, companies that are listing have had to prepare for this moment for at least two years, making many strategic decisions on the way. And once companies go public, they face increased scrutiny, regulatory compliance and disclosure requirements. They also face new challenges when it comes to their workforce, considering the impact of listing on current employees, potential remuneration changes, governance requirements and new communication needs.
When it comes to IPO-readiness, compliance is a top priority. Companies need to effectively assess where they are now, and what they need to do to remain compliant through and beyond their IPO. A key workstream that needs to be considered within this is share plans - an essential part of workforce remuneration. So how does a company ensure share plans remain compliant, and fit for purpose, in preparation for, during and after their IPO? We’ve teamed up with Suzannah Crookes, Legal Director at Tapestry Compliance to answer just that.
Importance of share plans through your IPO
Share plans are a key part of the remuneration package for the workforce. Designed to incentivise and motivate as well as to provide recognition and reward, the impact they can have in connection with key milestones in a company’s development should be anticipated from the outset.
Many companies already have some form of employee equity plan in place whilst they are still private. But this doesn’t mean that businesses won’t need to put in significant forethought to ensure plans work as desired on the road to going public. As companies prepare for their IPO, share plans can serve as a way to help drive the behaviours and performance goals needed to get the business ready for this major transition to the listed environment. Companies going through the listing process must also ensure that the share plans “land” as expected with participants, and provide that reward upon the transaction’s completion. In addition, companies must think beyond the listing process, and anticipate retention needs, ensuring ongoing drive to create value in the business. “Share plans, when designed and used correctly, can play an instrumental part in your IPO’s success,” says Suzannah.
What happens to your company’s equity at IPO?
Cap table
For private company shareholders, going public can be exciting because it is frequently the first time they will have had the chance to sell any of their shares and to realise the value they’ve created throughout the years in hard cash. As a private company, the investors, advisors, and employees who joined you early on and have been granted equity are part of your cap table. Depending on the capital structure ahead of the IPO and the structure of the transaction, there are likely to be significant changes and a “flattening” of the cap table at the time of listing. These changes may differ considerably from company to company.
Some of the changes that may occur to the cap table at IPO include: share class conversion - often to common stock, new share issuances to the public, changes to the amounts of reserved shares for different purposes like the employee awards pool, treasury etc. and stock splits to hit the desired share price at the time of listing. The shares on the “cap table” after the IPO can be grouped into different categories: those that are floated, those that are locked up, those reserved for strategic purposes (like employee share plans), those held by insiders, those held by major institutions and treasury shares. Because the public markets are more dynamic, these share structures and ownership change more regularly than in private markets.
Employee Equity and Share Plans
The changes to a private company’s capital structure at IPO will also impact employee share plans.
Employees may hold actual shares in the company prior to the IPO, and these will generally switch into the new or amended share class in the same way as shares held by any other individuals or investors. These could also potentially take any employee-specific contractual provisions that are applicable outside the share rights themselves. Employees may also hold share awards which are structured as the rights to acquire shares (i.e. options, SARs) at the time of the IPO. For these, the underlying shares over or by reference to which the awards have been granted should also switch into the relevant new or amended share class. These conversions may require calculations based on company valuations and different exercise or strike prices. It is also important to bear in mind the additional tax implications any of these changes might entail.
At IPO, employee share plans would typically fall into either the floated shares, locked-up shares or reserved shares for share plans categories.
How is your equity tracked and managed as a public company?
When a company goes public, share ownership and share structure can change fast and dynamically. In regulated public markets, a share registrar is required to manage shares and their movement.
The share registrar, also known as a transfer agent, is the record-keeper of public company shareholders (the equivalent of the cap table for private companies). While a share registrar has many responsibilities including maintaining accurate records, processing transfers, dividend distribution, shareholder communications and more, companies may also solicit nominee services for more convenient trading and set up an employee benefit trust (EBT) to administer shares that are specific to employee share plans. Nominees and EBTs are not a requirement for public companies (and a share registrar is), but they are common.
Specifically in relation to share plans, companies going public may wish to consider how they will source shares to satisfy share awards going forward and how employees may most easily hold the shares they receive. One approach which is common for UK companies is to set up an “employee benefit trust” (EBT) which can purchase shares in the market to use in relation to share awards. It holds unvested shares in trust until the awards vest or options are exercised. EBTs can potentially act as a warehouse for shares, helping to manage share usage and availability, and allowing companies to hedge their exposures to share price movement ahead of vesting events. Post-vesting, nominee accounts for share plan participants are potentially also a useful way to support individuals in holding shares for the longer term.
Nominees act as the legal owner (named in the share registrar) that hold and trade shares on behalf of beneficial owners. Setting up a Nominee before listing can be helpful as it may simplify the cap table and streamline the IPO, reducing the administrative burden on the day of listing. Typically, the shares held in nominee structures are some of those floated, those locked up, and those relating to employee share plans once they are exercised and/or vested. This can however vary based on the company and individual shareholder preferences.
In addition to the share registrar, nominee, and EBT, share plan administration software providers, like Ledgy, are used by companies to track employee awards and share movements, including both vested and unvested awards. These can and are likely to also include the beneficial owners within the nominee if a nominee is in use. Share plan management providers also enable trading and offer more features relating to automating vesting schedules and document generation, ensuring compliance, handling exercising and releasing, and robust financial reporting. In addition, they provide participant dashboards for them to view and manage their equity holdings, trade and generate necessary documentation, as well as serving as an employee communications portal from the company to the participants.
Getting IPO-ready
General overview and timelines
Going public is a large cross-functional feat. While companies may have been thinking about a potential IPO since their early days, some only start preparing for it a bit too close to their listing day. It is best to start the IPO-readiness process early, beginning by determining the viability and strategy of the IPO about 2-4 years before listing to allow ample time to prepare. This is when due diligence and planning should be done to determine what needs to happen for the company to be able to go public. Assessing financial performance, growth prospects and corporate governance practices as well as market conditions and optimal timing is needed. In addition, analysis of the valuations and positioning within the peer group can be done and it’s also important to start setting up strong financial reporting foundations to adhere to future requirements. For example, this is when you may need to prepare to adopt different financial reporting standards, like IFRS 2 for share-based payment expensing, and preparing for ongoing audits in the lead-up to the IPO can be enabled by dedicated financial reporting software. During this stage, you may also solicit external help from IPO advisors and auditors (which need to be independent of each other and from your selected auditors later on) to conduct a formal IPO-readiness assessment. Finally, a detailed project plan, timeline, team and budget should be developed to be put into action next.
At 18-24 months before listing, the bulk of the work towards IPO-readiness begins. This is when you would start to assemble the resources needed to go through listing: restructuring your board, hiring key people in finance and legal especially those that have been through an IPO and to account for the increased workload, implementing new tools and systems (equity, payroll, tax platforms) and engaging new service providers (auditors, law firms, PR firms, share registrar, etc) to help streamline the IPO and prepare for life as a public company. This is also when you would define your equity story, establish your investor relations and media strategy, select an underwriter and conduct roadshows. Documentation also needs to be finalised, with drafting the prospectus, preparing the required financial, marketing, and business information, executive compensation disclosures and more. In addition, this is when you would assess and redesign your share plans as well as associated communications to work through and beyond the IPO.
Because so much is happening and can only happen on the day of the IPO, it’s usually best to try to minimise the amount of changes that happen on the actual day where possible. In the lead-up to and on listing day, the transition is really put into motion. The final offering price is finalised, and many of your selected services like share registrar, nominee, and share plan management provider, are also fully set up to allow trading to start. New equity is granted and changes to the shares and their allocation as well as lock-ups and insider tracking start. The final required regulatory approvals are received, and required announcements are issued. In addition, this is an important time to think about IPO-readiness with a people lens as well, to activate and get employee communications right. As trading starts, employees may now need to perform certain actions for which they need to be prepared, and many questions are likely to arise.
Once listing day is done and a company is publicly traded, the work doesn’t stop. Planning for what happens when you are listed - a whole new regulatory regime with new disclosures, notifications and blackout periods - is needed. A working group focused on being public, set up prior to IPO, might help prepare you to transition more seamlessly. This can help ensure you are ready to meet the requirements of the selected exchange on an ongoing basis. It’s also important to start preparing for the trading that happens post-lockup periods, and after other larger releases or exercising windows. Stakeholder communications also remain important, as well as monitoring the strategy and performance of the company and adjusting where needed.
High-level summary of the IPO-readiness process:
At each of these steps, share plans are a key consideration and are likely to constitute a workstream of its own within the company’s wider IPO-readiness project. Share plans can be designed to optimise value throughout this process.
Share Plan design from pre to post-IPO
Setting up a plan design that will work from inception through into the listed environment can be difficult. For private companies putting in a share plan well ahead of an IPO, the most important consideration should be to find something which works for them in the pre-IPO phase of business development and provides the right incentive for the participants to drive growth, in alignment with strategy and working towards specific milestones. “While market practices may be evolving, it remains common for private company share plans to deliver value only on a liquidity event, where the medium- to long-term strategy anticipates this as an ultimate goal,” says Suzannah. This may be a takeover or IPO, or potentially a significant investment or other corporate action with material impact on value. Effectively this means that private company plan designs would reflect different business needs and resources than a public company would have. Therefore the preparation for IPO would need to address any potential issues that arise from the differences in business needs and resources between the private and public sectors.
One of those issues may be finding that an existing plan does not offer sufficient or appropriate levels of reward at the point of IPO. A company may then decide to grant further awards under the plan, or possibly to adopt a new plan, tailored to a strategy that foresees an IPO within a relatively short time frame. Because, in this case, there is a much clearer line of sight to the shape of that IPO and what it will mean for the business and workforce - including plan participants - plan design can and should take account of that. This means bearing in mind the retention of key individuals through and post-transaction, while also thinking about what should happen in the event that the IPO does not go ahead. “For example, companies listing in the US, in particular, may look at an “earn-out” arrangement, where senior executives receive additional value through share awards depending on share price performance over the immediate aftermath of the IPO,” says Suzannah.
Assessing share plan IPO-readiness & compliance gaps
When assessing the IPO-readiness of your share plans, the considerations to be made can be broken down into three main categories: What plans do you currently have in place? How will you manage your share plans through your transaction? And how do you ensure you are prepared for post-IPO life?
Current plans:
As you are assessing the plans that are currently in place, it is important to understand whether or not your records on them are complete, if equity compliance is on track and if the plan will achieve what you expect or want it to achieve during the listing process. “You need to get a clear picture of outstanding awards, what happens to them at IPO and assess whether the right people are suitably incentivised,” says Suzannah. “We frequently recommend a share plans ‘due diligence’ exercise to be done in the early stages of an IPO-readiness project. Relevant personnel generally have more time to look into this before the transaction gets going in earnest, and it is usually easier to fix any issues with a bit more time available,” says Suzannah.
The impact of the IPO on your share plans may point to changes that need to be made to existing plans. These could include any new tailored plan that needs to be introduced to drive and motivate people towards the completion of a successful transaction and share plans that can be used as a retention tactic moving forward as a public company.
Compliance gaps should also be assessed. “A legal review would help you understand if the shares can be delivered in the relevant jurisdictions, if there are applicable securities laws and exchange controls, or if further consents or approvals are needed and likely to be attained pre-transaction,” says Suzannah. If it is not possible to get the approvals you need pre-transaction, it may be possible for share awards to be paid out in cash instead - this needs to be tracked and accounted for when planning the transaction.
This assessment should also include a tax review. If you are looking to take advantage of any tax-beneficial arrangements it's important to understand if you meet all the conditions and if not, determine if you can fix it.
For example, UK tax-beneficial Enterprise Management Incentive share options are frequently granted by pre-IPO companies. These offer tax-advantaged treatment to employees in companies with gross assets of less than £30M and fewer than 250 full-time equivalent employees, subject to certain further conditions being met. It can be useful to review EMI options prior to a transaction in particular if options are likely to be exercised at IPO, so that compliance with the relevant conditions can be confirmed. This may be a question of investigating records held by the company and/or the option holders to ensure that applicable grant formalities have been complied with. “This is more easily tackled well in advance of the transaction. If a condition has been missed, then it may not be possible to secure the originally intended EMI tax treatment, but it may be possible to manage expectations, or to compensate an employee in some other way,” says Suzannah.
It is also important to understand if any taxes have been triggered already and if the compliance position is up to date. Another common approach in the UK for share incentives pre-IPO is the use of growth shares. Growth shares typically entitle the owners to a return where equity value has passed a particular threshold. In this case, unlike an option, the individuals will generally own the shares already. Depending on how the arrangements have been structured, employment taxes may have been triggered when the shares were first acquired. “It is helpful to confirm the position in relation to the tax paid and any tax elections which were entered into. This way, you can manage expectations on a sale of shares at or following an IPO and have enough time to track down appropriate records,” says Suzannah.
Share plans through the transaction:
When managing share plans through the IPO transaction, documentation is key. The IPO prospectus or Admission Document will need to include various disclosures concerning share plans, what happens to them upon the transaction, and potentially also information relating to individual awards, particularly at the Board level.
Depending on what happens to the plans at the IPO, you will need to enable the delivery of shares or cash. Ensure that you work with corporate teams to factor this in and that cash costs are incorporated into the transaction fund flows as appropriate. Global compliance actions—filings and reporting—also need to be completed within the correct deadlines and timelines, bearing in mind that some steps may need to be completed before the listing day.
Finally, it’s also important to manage tax liabilities. If awards vest on IPO and employment tax liabilities arise, you need to plan for how these obligations will be met, especially where there are employer obligations to withhold. If a “Sell to Cover” approach is taken at IPO, this also needs to be accounted for in the IPO planning as it will affect liquidity levels and would interact with lock-up periods. Lock-up periods are determined by the circumstances of the transaction. Communication about lock-up periods to participants is key so they understand that they cannot sell everything, and selling shares to cover taxes interacts with these lockups which needs to be communicated as this affects the potential cashout for employees. “Expectation management for employees is crucial as the company goes through the IPO.” says Suzannah.
IPO-specific plans:
Depending on what was in place before listing, some companies also look to offer one-off awards on IPO to reward employees for getting to that stage, celebrate or start creating a new employee shareholder ethos within the listed business. “This may also get employees more comfortable with share ownership before making decisions about putting their own money into a purchase plan,” says Suzannah. Governance best practices and investor expectations for listed companies need to be accounted for in plan design. The plan design should also factor in operational points for listed companies, such as dealing restrictions or blackout periods.
Share plans post-IPO:
As companies prepare for life after the IPO, many of them will bring in new plans appropriate for listed companies on the day of listing or shortly after. “It can be efficient to have the rules for a new plan approved at the time of IPO even if implementation will follow at a later date,” says Suzannah. These can be executive plans or broader-based “all-employee” plans.
Discretionary plans are typically driven by corporate governance considerations and market practice in the location of listing. “For example in the UK, we would expect to see companies listing on the Main Market adopt a long-term incentive and potentially also a deferred bonus plan,” says Suzannah. When designing the plans, it’s important to consider institutional investor expectations which typically follow industry guidelines, such as the Investment Association's Principles of Remuneration. There are also specific remuneration regulations that apply to the financial services sector.
The long-term incentive plan will typically provide for awards of shares that vest over a three to five-year period, subject to achievement of performance targets (sometimes referred to as “performance awards”), or satisfaction of a performance underpin (sometimes referred to as “restricted awards”). “Quantum is likely to be higher for awards with performance targets, to reflect the greater uncertainty as to vesting levels. Awards at the most senior levels will generally have a minimum overall vesting and holding period of five years, and will also be subject to vesting and post-vesting adjustment mechanisms or ‘malus & clawback’ provisions.” says Suzannah. “Investors will also expect plans to limit overall usage of new issue or treasury shares to 10% of issued share capital over a rolling 10-year period. The drafting of these dilution limits at IPO should be carefully considered and companies may wish to exclude any pre-IPO awards from these limits,” she adds.
Deferred bonus plans are arrangements where a proportion of the annual bonus is not paid immediately in cash, but instead, the value is delivered as a share award. These awards will not generally be subject to any further performance conditions but will vest after the specified deferral period, subject to continuing employment.
Companies can also more easily bring the wider workforce into share ownership once in the listed environment, with broad-based plans. “It is common to find broad-based plans initially introduced at this stage. For a global population, a global share purchase plan is a commonly adopted structure, possibly allowing for discounted purchase or for purchase plus a match,” says Suzannah. There are also tax implications to be considered and optimised for. “Discounted purchases are more common in the US, probably due to the tax-advantaged S423 plan structure. Discounted options funding through savings arrangements are another structure which can be used for all-employee contributory plans. This is slightly less common overall, but can be attractive in particular if looking to mirror a UK save as you earn or Irish sharesave arrangement.” says Suzannah. For a global roll-out, it is important to assess the feasibility of different plan types at an early stage. Simply adopting a plan on an “off the shelf” basis at IPO can store up problems for the future in particular if employees are promised participation, which then proves not to be cost-effective in their jurisdiction.
After the IPO, companies will also be considering wider remuneration governance and best practices. Share plan proposals may be developed in parallel with a policy on director shareholding requirements and remuneration committee terms of reference. If the company is putting a share dealing code in place, it is helpful to ensure this takes participation into account to avoid areas of ambiguity and make sure it is not overly restrictive.
Stakeholder requirements and communications
Effective share plan communications are an essential part of what can make them successful - not only for the company, but also for the employees. Going public is an opportunity to engage and motivate employees, allowing them to realise the value of their contribution and their equity through liquidity. During the transition from private to public, it is crucial to communicate with employees, manage expectations and ensure maximisation of the positive side of share plans in the IPO context. It is also necessary to provide financial education relating to their share plans, ensuring participants understand and appreciate the benefits. This in turn minimises the risk of non-compliance and unexpected issues like unawareness of tax liabilities to detract from the upside of share plans.
Expert tips from Suzannah
As Legal Director at Tapestry Compliance and having helped many companies get IPO-ready, Suzannah knows that preparing for an IPO is a busy time with many different workstreams competing for management attention. “My number one tip is to make sure there is a ‘share plans’ workstream on someone’s priority list ahead of the IPO,” she says. "Planning ahead can enable companies to get the most out of their share plans at IPO, both by ensuring the commercial outcomes are aligned with expectations, and by avoiding any last minute compliance headaches”.
There are also benefits to focussing on share plan compliance that should not be underestimated. “Because share awards involve the use of a company’s share capital, this is going to be under close scrutiny at the time of an IPO. Making sure you are on top of the details will help things run smoothly and avoid the risk of any delays in transaction timing.” says Suzannah. “At the same time, the value of share awards to the employees can best be spelled out by really effective communications. This can add enormously to the perceived benefits and help achieve a motivated workforce going into the post-IPO world,” she continues. Getting your share plans IPO-ready is essential for both the company and employees, and having the right partners and tools in place can ensure this is prioritised effectively.
How Tapestry Compliance and Ledgy can help
Tapestry Compliance is a share plans specialist law firm, providing advice across all aspects of the implementation and operation of share plans. The firm can support with plan design and documentation at all stages of a company’s development and in the context of planning for IPO. Their team can also help you structure your thought processes around existing plans, any new pre-IPO incentives, and what you wish to put in place for the business following the IPO. In addition, Tapestry Compliance offers a global compliance database, providing legal and tax information on operating share plans in over 150 countries. This is a cost-effective way for a company to keep on top of share plan compliance requirements, right from the initial feasibility stage (e.g., “Can we offer share awards in that country?”) through to the detail on delivery of shares at settlement (e.g.,“Are any filings required if shares are delivered, how do we manage foreign currency movements?”). The database indicates at each stage whether any tax is payable, the rates and any withholding obligations. Where the position is complex or follow-up actions are required, the Tapestry team can work with their global network to get the specific answers you need, and deliver these in the practical context of your plans, consulting with your other providers, such as Ledgy, to ensure a fully “joined-up” approach.
Ledgy provides compliant and automated share plan management for both private and public companies. Having Ledgy in place early, as you prepare and go through your IPO ensures accurate historical records and documentation are readily available to help streamline the transaction. With Ledgy in place, you can also successfully comply with disclosure requirements and financial reporting needs during and after the transaction. Additionally, Ledgy provides an intuitive experience and communication platform for share plan participants as the company goes public and real-time trading is enabled. On top of our modern platform, our team of experts and network of industry professionals, like Tapestry Compliance, are available to support you at every step.
Final thoughts
Going public is an exciting milestone for companies and their employees. Getting IPO-ready, however, can be a daunting task. With sufficient time planned to hire key team members, engage services, get your share plans into shape, and much more, you can ensure you remain compliant leading up to and after your IPO.
Share plans are an important workstream within the IPO-readiness journey as they can be a key incentive for the workforce through and beyond the transaction. Once the IPO journey is underway, you need to consider what happens to share plans during the transition, if they will have the desired impact for the company and for participants, and if anything needs to be done for them to work as they should and remain compliant throughout the process. It is also key to communicate about these clearly and make sure employees value them as they should, while managing expectations effectively.
While IPO-readiness and compliance as you transition from the private to the public markets can seem like a huge mountain to climb, having the right timeline and resources in place is the key to getting to the nice view at the top. “The best thing you can do for yourself is start early,” says Suzannah. This ensures you have ample time to execute your strategy and reduce the risk of things falling through the cracks.
For additional information on how Tapestry can help you stay compliant through the transition, visit tapestrycompliance.com, or send an email to info@tapestrycompliance.com And to learn more about how Ledgy can support you through your IPO, speak with an expert now.