SPAC vs. IPO: Is There a Difference in Executive Compensation?

An emerging company in need of capital to grow has an important decision to make: how and when to raise the necessary capital.

The traditional way of taking an emerging company public in an initial public offering, or IPO, is being displaced by a new method involving a SPAC, or special purpose acquisition company. A SPAC is a “blank check” shell corporation “created specifically to pool funds in order to finance a merger or acquisition opportunity within a set timeframe,” according to the Securities and Exchange Commission. “The opportunity usually has yet to be identified”.

The SPAC is typically led by an experienced management team of three or more members with prior private equitymergers and acquisitions, or operating experience. The management team of a SPAC typically receives 20 percent of the equity in the SPAC at the time of offering, exclusive of the value of warrants. The equity is usually held in escrow for up to two years, and management normally agrees to purchase warrants or units from the company in a private placement immediately prior to the offering. The proceeds from this sponsor investment (usually equal to between 2 percent to 8 percent% of the amount being raised in the public offering) are placed in a trust and distributed to public stockholders in the event of liquidation of the SPAC, which is required if a merger is not consummated within the specified period, typically two years.

Since the 1990s, SPACs have existed in the technology, healthcare, logistics, media, retail, and telecommunications industries. Since 2014, though, the amount of capital raised through SPAC IPOs has increased from $1.8 billion in 12 IPOs to $83.3 billion in 248 IPOs in 2020.

Pre- and Post-IPO Compensation Issues

Typically, all compensation plans and programs are developed and implemented prior to the IPO with the expectation that an IPO will occur over the next two to three years.The transformation into a public company, with all of its regulations and scrutiny, brings  the requirement for arms-length determination of compensation for senior level executives and board members..

The most important pre-transaction issue is to determine what the goals of the overall executive compensation program will be and to set about developing a strategy for achieving those goals. It is important to add two major caveats here: the first is to establish a longer-term executive compensation strategy that looks at least three to five years into the future and the second is to use equity wisely with the idea of keeping within grant size guidelines, as expected by investors.

In developing a compensation philosophy, a company should consider five main components:

  • Peer group comparisons: Who should the company compare themselves with for salary and short- and long-term incentive opportunities? This includes survey data sources for industry, size, and stage of development.
  • Pay positioning strategy: How should the company pay its executives in relation to the market levels of pay? Most companies target the median (50th percentile) as  fairest and most favorable to current and future investors.
  • Internal vs. external pay equity: How much weight should the company place on the relationships among executives (internal) vs. the market (external)? This is important for horizontal organization comparisons (e.g., CFO vs. GC) and vertical comparisons (e.g., management levels and layers). The depth of equity award eligibility (typically by salary or organizational level).
  • Performance alignment with business plan: How is the business plan aligned with the compensation system? The performance measures for the short-term incentive plan as well as whether to use performance measures for the long-term incentive plan. Some emerging companies use performance milestones as a performance measure for the equity award plan since there is typically nascent revenue and profit.
  • Cultural fit: Does it encourage employee and customer engagement? Compensation and employee engagement are inter related. It is difficult to achieve and maintain high levels of employee engagement without sufficient levels of compensation.

How Are SPACs Different?

A SPAC is similar to an IPO, and the levels of compensation (salary, bonus and long-term incentives) are very

similar in a SPAC and IPO for the same type of company in a similar industry. However, the major difference is the time period during which compensation planning can take place. For an IPO, typically all compensation plans and programs are developed and implemented prior to the IPO with the expectation that an IPO will occur over the next two to three years. For a SPAC, the capital has already been raised upon the SPAC formation and now there is a race to find and acquire a suitable company within 24 months.

Differences Between SPACs and IPOs with Regard to Compensation Benchmarking/Analysis

From a compensation standpoint, the key considerations in a SPAC deal are similar to those in a traditional IPO – pay levels and form of pay must be consistent with the market for the necessary talent to manage and grow the newly emerged company.  The urgency of the transaction sometimes gives management of the target company some leverage in the negotiation, which may result in a compensation premium.

On the other hand, the frenzy to find and capture a suitable merger partner, or target, within 24 months of the formation of the SPAC results in targets that have under-developed infrastructure, including compensation plans and programs. This frenzy sometimes overlooks the design and implementation of a director pay program. The board of director compensation program is put in place after the target company is acquired.

The SPAC is in control of the transaction. This difference manifests itself in a smaller equity pool, less frequent use of an evergreen provision, and conservative share-counting provisions. Based on a recent study of 24 relatively large companies of which 16 went the IPO route and eight chose the SPAC route:

  • SPAC share authorization is less than 50 percent of that for an IPO.
  • SPACs are less likely to have evergreen provisions.
  • IPOs are more likely to accelerate equity held by employees vs. conversion of pre-merger equity into the new equity.
Initial Employee Share Pool[1] (IPO vs. SPAC)
IPO SPAC
Plan Provision Prevalence

Evergreen[2]

87.50% 50.00%
Liberal Share Counting[3] 75.00% 50.00%
 

Share Pool

25th Pctl. 14.75% 5.25%
Median 15.00% 7.00%
Average 14.25% 6.75%
75th Pctl. 15.00% 8.50%

The Role of the Compensation Consultant/Advisor

Compensation consultants should be hired prior to the formation of the SPAC to assist with the executive compensation needs of the sponsor, particularly with the size of the equity pool and burn rate. This also allows for strategy and planning for the selection of a target company.

There are many decisions made upon the formation of the SPAC that continue throughout the process of acquiring and launching a new publicly traded company.

Typically, a SPAC is focused on an industry and company of a certain size. A compensation consultant can provide a sense of the compensation practices in that industry for the top executives, which could be helpful in the identification and negotiation of pay packages for key players.

Proxy Adviser’s View

Proxy advisers (and institutional investors) pay very little attention to SPACs.  Currently, they view them as typical IPOs. The main comment has to do with the independence of directors and extension of business combination deadline. There is little focus on the formation of the SPAC since it is only a holding company with no operating assets. The focus begins when the operating company is identified, acquired, and launched. At that point, it is assessed as any other publicly traded company.

Conclusion

While SPAC funding has exploded, care must be taken to make sure that employees are motivated and engaged to drive shareholder value pre- and post-SPAC. Once an emerging company is listed on the stock exchange it will take its place and normalize its compensation practices according to the respective industry standards. However, the transition from private to public can be rocky and must be managed carefully.

ENDNOTES

[1] The number of shares (as percentage of overall shares outstanding) reserved for employee stock awards concurrent with the transaction (e.g., IPO or deSpac).

[2] An evergreen provision allows a company to add a specified number of shares to its stock plan on an annual basis without obtaining shareholder approval for the allocation.

[3] Liberal share counting allows shares withheld or tendered for taxes or to pay the exercise price of an award to be available for re-grant.

This post comes to us from James F. Reda, national managing director and executive compensation service line leader at insurance and risk-management firm Gallagher HRCC.

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