Updating your employee equity compensation strategy is one of the key challenges companies face during the pre-IPO period.
The process of transitioning from privately-held to publicly-traded can bring with it massive change. While that may seem daunting at the outset of what might prove to be an 18 to 24-month journey, it is important to recognize that this can also be a time of great opportunity, with that certainly being the case as it relates to employee equity compensation offerings.
Modifying existing and/or introducing new equity plans
As a company progresses through the pre-IPO period, how it handles equity compensation will by necessity change. This can mean modifying existing plans and/or introducing new plans, and it can also often make sense on a practical level to move on your equity compensation strategy prior to flotation.
It is important to stress that looking to introduce new plans prior to going public isn’t about exploiting a loophole in the process or avoiding oversight. On the contrary, any new employee equity compensation plans introduced during the pre-IPO period will need to abide by all regulatory requirements relevant to publicly traded companies.
The practical logic of introducing new plans while in the process of going public is two-fold: a private company may only need to seek approval from a relatively small group of founders and investors, whereas a public company will require wider shareholder approval. This means it can be easier for a private company to move quicker on decisions in the pre-IPO period rather than waiting until the shares are openly traded before beginning to overhaul any equity arrangements.
Reassuring employees during a time of change
Whether you are public or private, the main goals of offering equity compensation will be the same – to attract, motivate, and retain employees.
In the context of the pre-IPO period, an added consideration might be a desire to offer reassurance to employees who may be feeling some anxiety around what the future might hold. Such apprehension may be unwarranted, but is nonetheless understandable. Offering new equity incentives and broadening the eligibility base can be a way to flip this and instead boost morale and generate enthusiasm around going public.
Whatever you settle on, try to keep the messaging around and rationale for the equity plans you introduce as straightforward as possible to clearly show their potential value.
It is not enough to just offer your people an attractive opportunity. They need to understand why and how it can prove beneficial to them. That means putting in the necessary time and effort into communication and education. If people don’t understand how something can benefit them, then they will not fully appreciate it, and you will most likely not achieve the desired outcome.
What types of plan to introduce during the pre-IPO period?
There’s no one-size-fits-all solution and you might choose to target different groups with different plans, depending upon your company’s objectives.
Among the possibilities are:
Employee stock purchase plans (ESPPs): ESPPs can be a popular choice when a company is looking to broaden eligibility to most or all employees. Under a plan of this type, companies typically make shares available at a discount (5% to 15%), with the set price based on fair market value (FMV) on the first or last day of a defined offering period, usually using whichever price is lower, as the starting point. You might see this referred to as a ‘lookback’ feature.
There are two types of ESPP – qualified and non-qualified. Qualified ESPPs receive more favorable tax treatment, whereas there is more flexibility in how non-qualified ESPPs can be designed.
In the past ESPPs were mainly used as a vehicle for public companies, however changes to securities laws since 2012 have seen this option rolled out more upon an initial public offering in companies looking to rally human capital.
Stock options: With stock options, a company grants employees the right to purchase a specified number of shares at a set price commonly with a vesting schedule attached, linked to performance and/or time.
There are two distinct types: incentive stock options (ISOs) and non-qualified options (NSOs). ISOs are granted under a formal stock plan and abide by rules that make them eligible for favorable tax treatment. When options don’t stick to those rules, they are deemed to be NSOs and receive less favorable tax treatment.
Restricted stock: With restricted stock, employees are awarded company shares, but the vesting terms dictate when they will actually receive those shares.
Shares can be granted for free, at a discount, or in line with FMV.
Depending upon how they settle their tax liability, employees may receive favorable treatment. If they opt for a Section 83(b) election, participants pay their tax bill at the outset, with the logic being that they will benefit if the FMV increases over time. This can work out well, but is also somewhat risky. For example, in the event of shares being forfeited during the vesting period, participants can lose out, as any Section 83(b)-related tax payment will be non-refundable.
Employee equity plan administration
The pre-IPO period is a logical time to review all aspects of your equity compensation regime. Beyond looking at modifying existing and introducing new plans, this also means examining your stock plan administration practices.
How have you administered your plans as a private company? Has your default approach over time been to keep track of all relevant information manually via a spreadsheet? That might have made sense early on, but the requirements will become more demanding over time, and no matter how well you have tracked awards, vesting, and forfeitures during the life of various plans, when you rely on manual entry, the possibility of human error is ever-present, i.e., accuracy cannot be guaranteed.
Contact us now
At J.P. Morgan Workplace Solutions we provide businesses of all sizes with an all-in-one equity compensation management solution. We handle all the equity award administration so you’ve got more time to focus on your company’s journey. Get in touch today to find out how we could assist with equity design and management at this crucial time.
This publication contains general information only and J.P. Morgan Workplace Solutions is not, through this article, issuing any advice, be it legal, financial, tax-related, business-related, professional or other. J.P. Morgan Workplace Solutions’ Insights is not a substitute for professional advice and should not be used as such. J.P. Morgan Workplace Solutions does not assume any liability for reliance on the information provided herein.
