Managing expectations in an IPO: there are sensitive, and subtle, issues that the compensation committee will need to anticipate.

• Author: Ferracone, Robin
• Position: COMPENSATION AT WORK

HIGH-FLYING IPOs like LinkedIn, Pandora, Zillow, and HomeAway have valuations that range from 5x to 15x projected revenue and defy gravity. On the heels of these recent IPOs, the financial press is filled with news about other eagerly anticipated offerings from such companies as Groupon, Zynga, Kayak, and LivingSocial.

But once public capital is raised, it must be profitably deployed. While sometimes described as an "exit," an IPO cannot be viewed as such by the management team who must execute the strategy to support the lofty expectations embedded in the company's stock price. To sustain soaring growth and prove out their business models, these companies must plow capital into exceptional talent who can lead and scale the sales, marketing, product development, and operations functions.

In compensating that talent, it's easy to think that the most significant post-IPO challenge will be handling the volume of new hire offers. But the fact is that there will be other more subtle issues that the compensation committee and board will need to anticipate. For example, in one recent IPO situation, the CEO expected to be "topped up" with stock options in order to preserve the same "ownership" percentage that he had prior to the IPO. Was this claim a shrewd negotiating ploy, or an innocent misconception? Either way, the compensation committee had to explain to the CEO (over a series of conversations) that as with most IPOs, the executives would not be "topped up," and additional dilution of the management's ownership stake would likely occur from future stock issuances following the IPO.

There's also the matter of the "haves" (i.e., those who got rich on the IPO) and the "have-nots" (i.e., those who came into the organization after the IPO). After the IPO, there are likely to be diverging wealth accumulation opportunities. The best thing to do is to just play it straight and let people know that it's not realistic to think that there will be parity in executive wealth. Why? Because the risk wasn't the same either.

Instead, the compensation committee is better off focusing on what people can expect. They can expect that the company will treat people fairly relative to the market and relative to each other in salary, annual bonus, and annual equity grants going forward. Moreover, they can expect that there will still be very attractive upside opportunities as the company grows and realizes its potential. LinkedIn is a good case in point. For the two...