16. Equity Compensation Design in Pre-IPO and Growth Companies

Entrepreneurs start companies in all economies, with down
economies often seeing the most start-up activity. Designing effective
employee compensation plans for these companies is a critically
important issue, with equity-based pay receiving the most focus,
rather than cash. Equity is the most effective means to align business
success and compensation, while conserving precious cash, which
can be used to grow the business. This emphasis on equity compensation
is a big part of what differentiates growth company compensation design
from that of mature companies and will be the
focus of this chapter.

Compensation professionals working with growth companies
must have a detailed understanding of their unique equity compensation
design issues. Though pre-IPO and growth companies may be
viewed as “immature” compared to a Fortune 200 company, this
does not make designing and administering their equity plans
comparatively easier. In fact, plan design and administration in
growth companies is often more difficult, due to the number of
unique considerations, practices, techniques and metrics that may
seem foreign to professionals accustomed to typical mature-company
compensation methodologies and reasoning.

The goal of this chapter is to provide the needed background
education for pre-IPO and growth company compensation professionals,
as well as to provide a new framework for developingoption grant guidelines.
The chapter is presented in three sections addressing:

1. The types of equity commonly used, why they are used, and
their advantages and disadvantages.

2. How private placement financing and market illiquidity
cause pre-IPO design and measurement to differ from mature
companies. This will include guidance on how to incorporate
expected private placement dilution into stock planning models, as
well issues related to option pricing and grant timing.

3. A novel approach for developing option grant guidelines in
pre-IPO and growth companies using annual option usage as a
guide, rather than “traditional” value-based metrics (which the
reader will see are subject to distortion from pre-IPO stock prices and
post-IPO price volatility). This section is applicable to compensation
professionals in public growth companies (e.g., high-tech or biotech),
as well as late-stage pre-IPO companies. —Editors



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