December 5, 2022 Executive Compensation ESG & Human Capital Management Articles

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Private-to-Public Companies, Their Governance Models, and Influence on Pay

Private companies and private equity- or venture capital-backed pre-initial public offering (IPO) companies fall at one end of the governance and compensation spectrum.

On the other end are family-owned or enduring private companies. Private equity- or venture capital-backed pre-IPO companies tend to align compensation very directly to the investors in more highly leveraged programs, and often begin to follow public company best practices and governance decision-making as they drive toward a liquidity event (either an IPO or sale). Family-owned companies or those with enduring private ownership typically have less risky compensation programs, with greater emphasis on cash flow or capital preservation, and focus on board governance through an advisory lens, with the board often having fewer formal decision rights. 

In our work with clients on executive compensation and human capital management (HCM), we have seen these differences manifest in the ways detailed in the chart. 

Traditionally, many emerging best practices around human capital are not focal points at pre-IPO and enduring private companies. However, companies start to shift toward the traditional public company model as areas such as diversity, equity, and inclusion (DE&I), culture, pay equity, and reskilling are proven to impact performance. Many enduring private companies have focused on some of these categories for a long time. 

Type of CompanyGovernance-related CharacteristicsImplications on Pay and HCM
Traditional Public Company (Broadly Held) – Typically has a broad shareholder base
– The majority of the board is independent
– Subject to disclosure requirements, regulations, and proxy advisory and best practice norms
– Uses outside third party for advice and counsel 
– Process-driven decisions
– Pay design and levels often anchored around market peers
– Generally limits the range of designs to fall within market norms and is concerned about external perceptions if it deviates from “typical” practices
– Decisions intend to balance multiple time periods (short, medium, and long terms)
– Dilution is managed within market norms and often includes broader participation 
Pre-IPO Private Company – Narrow shareholder base, typically direct investors; as a result, company directors are typically more hands-on and directive than most others
– The board comprises owners and investors (private equity and venture capital) with a few independents as the company gets closer to a liquidity event
– Not yet subject to all regulations and disclosure requirements, but develops programs with an eye toward adopting public company practices
– Begins to use outside third-party advice and counsel more regularly 
– Decision-making and process are less formalized
– Pay decisions are oriented toward acceptable public market practices
– Shorter-term orientation to align with a potential liquidity event for investors
– Equity usage and dilution are typically a direct negotiation with owners, and are often lower than at a traditional public company because of the potential wealth creation opportunity from up-front grants
– Pay design, particularly equity, is often more performance-based than in a conventional public company 
Enduring Private Company – A small group of shareholders (typically family) that are long-term holders
– Advisory board with varying degrees of authority and decision rights
– While these types of companies are subject to some US Securities and Exchange Commission and stock exchange rules, they are generally not subject to the same level of external regulations and reporting requirements as public companies 
– Process-driven decisions are similar to those of a public company; however, the majority of decision-making power is within a few hands
– Decisions more focused on longer-term performance, company mission, and employee experience
– Long-term orientation to pay with greater stability; flexibility to use more discretion to ensure pay outcomes seem reasonable and fair over time
– Pay programs are often less risky, with a view toward capital preservation
– Overall equity and dilution are typically very low, especially in family-owned companies; cash is often used as a substitute 

In summary, many aspects of a private company’s ownership profile and resulting governance model affect pay and human capital-related decisions. Enduring private companies may have pay programs that are more stable and less risky than private companies with investor owners who need to generate a return in a shorter time period. Understanding the nuances of these different models and the various stakeholders involved provides a good starting point to determine the potential outcomes and best path forward for a company’s pay design and human capital decisions. 

View the full article as it was originally published.

Stephen Charlebois

Greg Arnold

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