The Life Sciences IPO Playbook: Key Compensation Decisions Before Going Public

Jake: In this season of Pearl Meyer Unscripted, we're looking at executive compensation through an industry lens. Our co-hosts, Mark Rosen and Aalap Shah, are joined by several colleagues who specialize in different industries, including technology, healthcare, oil and gas, and more, to examine the aspects of compensation design that are unique to each.

We're wrapping up our life sciences discussions by examining the compensation issues life sciences companies should address when preparing to go public. Mark and Aalap are joined by managing director Rob James, whose work includes helping private companies prepare for IPOs, reverse mergers, and other go public transactions, as well as helping public companies navigate the compensation and governance demands of a public company environment. Let's listen now. 

Mark: Hey Rob, thanks so much for joining us today. Really appreciate you being on the podcast.

Rob: Absolutely, happy to be here.

Aalap: Rob, really going to enjoy this conversation, I think.

Mark: So let me kick it off with what this is all about. When a life sciences company starts thinking seriously about going public, what should it do first and how early is early enough?

Rob: It's a good question. You know, I'd like to start by covering the two different camps that I find that most companies fall into when we start working with them on IPO related items.

The first camp is what I like to call sort of the “pre-emptive planners” that typically have a lot of lead time for the IPO, you know six to nine months, they're pretty far out and they'll come to us early in their process and they’ll say, “Hey, you know, here's where we're headed, what do we need to get done over this period?”

Versus the other kind which is companies that are a little bit more last minute, not because they're not planners, but perhaps because there's more of a window of opportunity that they're trying to take advantage of, and their timeline accelerates, and they're trying to get a lot done very, very quickly.

In either case, the first step is the same, and that is really building a good IPO timeline with respect to comp. That timeline is going to cover the deadlines, obviously, that we're working against, what the key work streams are, who the key decision makers are, and what the decision points will be.

What I found is, actually, when it comes to decision making that's one of the things that's often actually overlooked, right? The biggest challenge is not the data or the design work it's, actually getting the right people into the room together trying to build consensus and getting the right approvals during what is a pretty high stakes period. So again, in either case, I think the first step is getting a good sense of what needs to get done.

Mark: Who are the right people to get in the room?

Rob: We need to have close coordination within HR and then bring in finance and legal, because not only are we talking about the compensation programs and the design of those programs, but also, there are budgets that are related to the comp programs, there's dilution through the use of equity, et cetera. Those typically sit with finance. And then of course, a lot of the plans and policies that go into effect at IPO are legal documents and they need to be drafted by legal. So, we'll start with those three groups, but also, we need the compensation committee, so the chair and the members, and then maybe even certain members of the board, like the board chair as well.

Once we've got our timeline together, we can really start focusing on the actual work streams themselves. The first work stream that we'll work with companies on is really to build this IPO peer group, which serves as the basis for a lot of our compensation related decisions. We'll use it to assess executive cash comp, the equity positioning, to review the structure of the employment agreement, and look executive severance and change-in-control protections. We'll also use it to help develop or design the equity plan so the size of the equity pool, which provisions should be in there, things like the ESPP as well, right? We'll use it to help frame all of that.

In terms of how early is early enough, I'd say the ideal target is to start three to six months before the IPO date, but there's certainly no reason why you couldn't get started earlier. You know, I've worked with companies who want to start pressure testing their comp programs against public company benchmarks nine to twelve months out. So, I think you can certainly start earlier if timing allows.

Aalap: A question on that, Rob. For a company that might be pursuing a dual track, so being acquired by a company or an IPO, does it make sense to start earlier?

Rob: Yeah, I mean I think with any transaction there's usually a lot to think about. It's actually maybe not the things that you can think of, and plan for, it's more the things that you can't think of that tend to trip you up. In general, if timing allows for it, I think it's better to try to get ahead and to do as much pre planning as possible just so that we have some buffer in the event things come up and we need to pivot or do something different. So ideally, I'd say start as early as you can in the process.

Aalap: So, what makes IPO compensation planning in life sciences different? And does it matter if it's an IPO, a SPAC, a reverse merger?

Rob: Yeah, obviously the transaction mechanics are different in a reverse merger or a SPAC, but in terms of what actually needs to get done, the actual work streams are pretty similar to an IPO. But what makes it different? I'd say the first thing is that going public is often a natural and, in many cases, an inevitable part of a life sciences company's growth story as it provides access to capital, right? So, they're obviously various stages of development and they need access to capital in order to continue that development to meet milestones and to essentially continue along their path of commercialization. So, in a very real sense, I feel that the public markets are a lifeblood of this industry.

The second point is, I think that more than any other industry, life sciences companies rely more on equity compensation. So, this has implications at an IPO, it means we need to think carefully about sizing the equity pool, forecasting burn rates and dilutions, thinking about the evergreen at the IPO and what the right size is there.

The other big difference with this industry is that volatility is something that we're all used to and would expect. It's certainly part of the game in life sciences. And so, expecting there's going to be some volatility at the IPO, but also after that, would be normal. I think that has some implications on things like retention and motivation, right? Particularly in an industry that has historically relied on stock options.

We’ll get a lot of questions around “How should the LTIP evolve at the IPO and soon thereafter? Should we start thinking about, for example, restricted stock units and we know that the prevalence and the usage of RSUs has increased, so like how soon is too soon? And what weighting should it have in the LTI mix?” And we'll also, typically, at this time start to receive questions around things like IPO grants and should we think about doing something at an IPO to reinforce retention or motivation and they're fairly common. I think the answer there is not an automatic yes or no, it's really more of a question of what's appropriate based on current holdings and competitiveness and holding power and all of those good things. But we've seen usage of RSUs to strengthen retention through this period and try to mitigate some of that volatility risk.

Aalap: And so, diving deeper into the volatility question, how do you think about that interplay between volatility shortly after the IPO and what is that mix of grants that you might do at the IPO?

Rob: I think a longer-term architecture for LTI what I might expect after an IPO is entirely options, right? It's still pretty common in biotech, or a gradual movement away from entirely options to some RSUs. Whether that's an eighty-twenty mix, so 80% options and 20% RSUs, or seventy-five twenty-five, you know, I don't think it matters too much.

The point is, we might see, over time, those sorts of vehicles will trickle in. And I'd also say certainly that there can be different mixes across the organization, right? So, you might find that executives will continue to have a very heavy emphasis on stock options versus RSUs, whereas it might be a little bit more equally weighted down the line.

The at IPO grants, so I'm talking specifically about awards that could be issued and are often issued around the IPO. It's usually options, but I have seen companies choose to grant let's say an RSU, a two-year cliff RSU, for example, specifically because they've identified within their population a group of people who are critical talent that they can't afford to lose. They know that there's some volatility and they want to reinforce and re-up retention strength. And so, there's a kind of a strategic usage of RSUs at the IPO. And so that might be a slightly different mix to what you might, again, find in a more ongoing annual LTI program.

Mark: One of the things that we often see in an IPO is an employee stock purchase plan. And they seem very simple on paper, but the timing decision can be very meaningful. It's another way to get some discounts to your employee also over the prevailing stock price. Should companies launch an ESPP out of the IPO or just approve it and hold it for later? What's your experience?

Rob: Yeah, so what we see is, as you point out, many companies approve an ESPP at IPO but end up actually waiting to launch it until a later date. Based on the research we've done, that's the majority of companies. So, they'll “approve and shelf it” is kind of the expression. And the reason they do that is often just because they may not have the systems or the platforms in place to be able to launch it on day one. So, that's the most, sort of, prevalent kind of practice.

But to your point, Mark, these are valuable employee benefits. And so, my advice has been to my clients, if you can put it in at IPO, absolutely it's seriously worth considering and you should try to do it. It will allow potentially your employees to receive a discount on the IPO price through the offering period, we know that that can be as long as 27 months. And I think it's just an incredibly powerful kind of reward mechanism if you are able to reward employees that have been with you since the early stages of the company through the IPO and beyond, why would we not want to do this? I think again, it's kind of a powerful benefit. You know, we don't want to force it, but at the same time, if you can do it and do it well, I think it's absolutely worth considering.

Aalap: On the last podcast, we discussed evergreens a bit. For companies prepping an IPO, is there a debate to be had around 4% vs. 5%?

Rob: You generally have one shot to get an evergreen in place, and that's at the IPO. If you look back over data in the last five years in the life sciences sector, you're going to find a lot of support for 5%. When you do an analysis and you look at the prevalence statistics, almost certainly that it's going to say 5%. However, you know, having been in boardrooms over the last few years, I will say that I've heard some investors express the view that 5% is more of a COVID era or hot market practice rather than what should be the right kind of go forward standard. And to be clear here, if it's not 5%, it's 4%, right? So, this is not big differences in absolute terms, although the difference does matter, particularly in today's environment or the environment recently where valuations have generally been lower and there's therefore kind of more sensitivity to dilution and scrutiny around the equity plan and its provisions in general.

So, there's a debate to be had, although I wouldn't reduce the answer to just "oh, it should be 4% or 5%," rather I think the right answer depends on what your hiring needs are, what your equity needs are, and what your equity positioning strategy is, what your investors' expectations are, and then, of course, the company's actual ability to tell a really good and credible story around dilution to be able to kind of justify, “hey it needs five or it needs four.”

Aalap: Right. And so just to probe on that a bit more, because the difference between four and five percent, as you said, it's not a huge difference, but I think what you're signaling to the external market and also internally to the employee population, it does have a meaningful impact. But when you think about the comments you made about the volatility of the sector, would it be wise for companies to err on the higher percentage and just not use it? Because they don't have to re-up that every year.

Rob: Right, and that's a good point because of course the language is usually written as the lesser of 5% or an amount to be determined by the board. And so certainly, you have the ability to do something. In practice, we find that the evergreens sometimes become a little automatic. I don't think they should be, and absolutely, I encourage my clients at year end to ask the question, "what do we need" versus "what can we get?" So, I think if you have the discipline, the internal discipline, and you have a comp committee that is supportive, going for 5% can provide you that optionality, no pun intended. But to be able to do what you want, if you need to, if the shares are underwater and you need to do something, you know, special to try to reinforce kind of retention if you have a bigger evergreen, you're just more able to do that. So, it's a nice to have.

I think the other side of that coin is that, if it's there and available it tends to get spent. And I think that's the concern among investors is that evergreens kind of become a sort of a dilution tax and while it only sounds like 1% per year, obviously compounded over the life of a ten-year plan on an ever-increasing common shares outstanding number, the dilution it really adds up over time.

Mark: It's been a really good discussion. Thank you so much for joining us today. We look forward to continuing this conversation elsewhere.

Rob: Well, thank you. I enjoyed it.

Aalap: Thank you, Rob, and get some sleep with all that IPO prep you're doing.

Jake: Thanks again to Rob for his thoughtful perspective around the compensation issues life sciences companies should address when preparing to go public. 

On our next episode, we will turn our focus to the oil and gas industry. This industry has undergone significant change over the last decade, driven by consolidation, capital discipline, evolving investor expectations, and continued commodity price volatility.

In our next episodes, we’ll explore how compensation committees and management teams are adapting executive compensation programs to reflect these new realities. Until then, you can find all of our Unscripted episodes on Spotify, Apple Podcasts, pearlmeyer.com, or wherever you get your podcasts. Thanks as always for listening, and we’ll meet you back here next week.