Before a private company signs a letter of intent with a SPAC investor, business leaders should ensure their executive compensation plans are in good standing and commit to a deeper governance audit once the deal is signed.
Traditional IPOs give private firms months (if not years) to prepare for the governance requirements of being a public company — including adjusting compensation plans and hiring independent directors, for example. The explosion of special purpose acquisition companies (popularly known as SPACs) in the market highlights one of the things “reverse merger” deals don’t have — time to prepare.
A shorter timeframe to prepare to be a public company forces the target company to act quickly, ensuring compensation plans meet the evolving needs of the firm and that governance processes are addressed in connection with the transaction (commonly known as the “de-SPAC”).
In this article, we’ll explore the biggest compensation and governance issues private companies should address and then plan for when thinking about going public through the SPAC process.
Adjust Compensation Plans Before a Deal is Signed
When a company is ready to sign the letter of intent with a SPAC, it should ensure its compensation plans are in order and make any necessary adjustments before signing the business combination agreement. Once this agreement to merge is signed, the SPAC will need to approve any changes, which can complicate the process.
In a traditional IPO planning scenario, we recommend leaders establish or review their guiding compensation philosophy, what they can afford on cash and equity programs, internal pay equity and pay for performance alignment. There’s little time for that kind of deeper analysis if not looked at before a letter of intent is signed for a SPAC deal, however. The target company needs to be pragmatic and look at what changes to executive compensation, including equity issuances, can be done before the company becomes public.
Here is a checklist of items to tackle first and quickly to ensure your compensation programs are ready for when the de-SPAC is complete, and the company is public:
- Update broad-based and executive peer groups. Peer groups will shift from pre-IPO and private companies to public companies of similar size and industry and/or where the company is competing for talent. Keep in mind that the COVID-19 pandemic has accelerated the number of employees working remotely, effectively widening talent pools. Private companies are more likely to hire from local talent pools but that will likely change with the infusion of capital from the SPAC — therefore, new peer groups may need to include businesses outside of the local market or industry.
- Review employment agreements and future change-in-control provisions. Executive officer employment agreements and severance provisions must align with public company norms at the time of the closing. In addition, many incentive plans include CIC provisions for more traditional transactions and don’t apply to SPAC deals. Determine whether your incentive plans need to specify SPAC deals more explicitly. In addition, if the private company does not have any severance arrangements, it’s in stakeholders’ interests that key executives have reasonable employment protections that allow them to focus on executing strategy and driving performance.
- Determine pool size for public company equity incentive plan that will be approved by the SPAC’s shareholders. Determine the ideal number of shares to authorize given what’s already outstanding and the company’s future headcount growth needs. We typically recommend the plan include an annual evergreen feature since it allows for an automatic, formulaic increase in plan reserves, typically at the start of each new plan year.
- Decide whether to introduce an employee stock purchase plan (ESPP). ESPPs can add a lot of employee value with minimal cost and are more widespread depending on company industry and size. To learn more about ESPPs, please see our article on plan prevalence here and plan design here.
Integrating the Board and Establishing Director Pay
A SPAC acquisition is complicated and requires effective communication between the business leaders and the boards of both the SPAC and the target acquisition to be successful. Following the de-SPAC transaction, the new public company board is typically comprised of one to two members of the SPAC board, the founder and the CEO of the target company as well as new independent directors recruited by the target company during the process. Therefore, it’s important for the combined team to build a positive relationship from the start.
The target company will need to determine its director compensation in order to recruit directors to sit on the board when it becomes a public company. We advise the company to meet with external advisors to determine the market rate for board compensation based on the company’s size and industry following the de-SPAC. As with many governance issues, director compensation has received extra scrutiny from investors in recent years and public companies need to establish fair pay plans that are not deemed excessive by proxy advisory firms and institutional investors. The largest proxy advisory firm, Institutional Shareholder Services (ISS) deems director pay excessive if it is within the top 2% to 3% of companies in the same sector and index. In addition, director compensation should be in line with peer companies to withstand recent litigation, as director pay is subject to a higher legal standard than executive pay and has been the focus of plaintiff attorneys in recent years.
Addressing Governance Processes Once Public
With investors increasingly scrutinizing the governance policies of public companies, including those that are newly public, going public through a SPAC means your company will need to quickly understand governance issues.
Consider that a few years ago, ISS began recommending investors vote against or withhold votes from the entire board of a newly public company (except new nominees to be considered on a case-by-case basis) if the board adopts bylaws or charter provisions that allow for what ISS deems egregious governance policies. These include, but are not limited to, supermajority vote requirements, a classified board structure and a multi-class capital structure.
As the private company will not have had experience with public company governance requirements, business leaders will rely heavily on the expertise of external advisors to ensure that governance issues material to the company are addressed.
Many companies adopt similar governance documents as IPO companies that contain company protections and entrenchment such as staggered boards, plurality voting, dual classes of common stock with high voting shares and supermajority requirements to amend the charter and by-laws, but these can be controversial from a broader investor perspective. Messaging and proactively agreeing to sunset certain of these controversial shareholder rights and practices a few years after the De-SPAC will demonstrate to institutional investors that a company is interested in reducing company control over time.
Recruiting independent board members from diverse backgrounds (e.g., gender, race, ethnicity, work experience) will also ease institutional investor concerns. In addition, ensure that the committee members and their charter documents include oversight of issues important to these investors such as human capital management, cybersecurity and environmental, social and governance factors (ESG). Develop a robust annual independent board evaluation process to ensure that the new board and its committees are working effectively.
As companies that go public through the de-SPAC process often are not considered newly public beginning with their first annual meeting post de-SPAC, they need to develop a plan of disclosing their overall ESG strategy to stakeholders. While certain public disclosure is required (e.g., director bios, their independence, committees and charters, human capital disclosure), the level of detail can vary, and many institutional investors are expecting more robust disclosure. As part of this, showcasing an awareness of ESG on a company’s website and in its first proxy statement can also help to position a company that has gone public through the de-SPAC process favorably relative to investors, customers and employees.
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If you’d like more information about how we support compaies in SPAC transactions or public companies with their governance policies, please write to rewards-solutions@aon.com.