Potential IPO Red Flags

We have noticed an increasing number of floats coming to market with executive incentive plans that contain features not in accord with broad market practice and, frankly, incoherently structured.

Transitioning to a listed company

Whilst acknowledging that market practice should never be the sole driver for the design of such plans, we caution the Boards of newly listed companies against adopting plans that potentially raise red flags to more sophisticated institutional shareholders and/or proxy advisors.

Some of the features and the potential questions / issues that may need addressing include the following:

Pre-IPO / Post-IPO transition

  1. Whilst pre-listing incentive plans should not ‘contaminate’ post-listing plans a key issue is: has an effective and thorough transition been addressed from a performance incentive perspective? How is the proposed new executive remuneration mix different from the corresponding legacy private market arrangements?
  2. To what extent have the proposed post-listing incentive arrangements had regard to the escrow arrangements relating to pre-IPO equity? Will new investors at the IPO be satisfied that KMP retention risk has been sufficiently addressed and mitigated?
  3. What are the critical stakeholder considerations relating to the proposed listing? That is, is a conventional public listing structure contemplated or is the listing part of a demerger transaction involving an external capital raising component?

Short term incentive

  1. If the new short term incentive (STI) plan now includes a broader set of key performance indicators (KPIs), what are the incentive implications of including ‘below-the-line’ financial indicators and non-financial indicators alongside traditional pre-listing ‘above-the-line’ indicators? Is there a minimum proportion of the incentive contingent on financial indicators?
  2. From a performance incentive perspective, what are the implications of differentially weighting the STI KPIs? How do the selected financial KPIs align with Prospectus forecasts?
  3. Should a performance gateway be introduced as a precondition for any STI award? Where should this threshold level of performance be set? Should only financial performance gateways be included?
  4. Does the Board intend on rewarding achievement of non-financial KPIs despite threshold financial performance not being achieved? How would such an STI award be funded?

Long term incentive

  1. When are options a better instrument to grant executives under a long term incentive (LTI) plan than performance rights? Are the desired executive performance incentives the only consideration? Are there guidelines for aligning new investor expectations with the reward expectations of the leadership team? What are the related Corporations Act, ASX Listing Rules, ASIC, tax and accounting considerations?
  2. Is it a prerequisite for the new LTI plan to contain at least two performance measures? Do these always have to be an external, market-based measure and another internal, earnings-driven measure?
  3. Why would the Board wish to weight the two LTI performance measures other than 50% each? Do, and should, the escrow and projected future selldown arrangements influence this decision? What about the immediate accounting implications to the company?
  4. How should the Board decide on the most appropriate comparator group to adopt under a relative Total Shareholder Return (TSR) performance measure? Should this simply reference a benchmark ASX index? What are the risks of including / excluding companies in particular sectors and/or industry groups? How is this decision influenced by the proposed TSR vesting schedule?

The above are only some of the increasing number of issues Boards are grappling with when putting in place executive incentive plans for an IPO. Whilst the relevant issues can be finalised post-listing, it is often a more difficult and more involved process with a greater number of new stakeholders.

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