Going public has become a gleam in the eyes of many entrepreneurs and stock market investors. Visions of quick profits have been inspired by the success of recent high-profile initial public offerings (IPOs), such as those from United Parcel Service, Martha Stewart Living Omnimedia, World Wrestling Federation Entertainment, Goldman Sachs and eToys.
In fact, the hot IPO market raised a record $69.2 billion in capital through late December, surpassing the annual record set in 1996, according to Thomson Financial Securities Data. (1996 retained the record for number of IPOs—872, compared to 546 in 1999.)
While the potential rewards exhilarate private and public investors, going public can be an emotional roller coaster ride for employees. Staff at all levels will experience the highs, lows and turns in unexpected directions.
At first, especially in the pre-transaction period, everyone is excited to be "on board." But the ride doesn’t stop for 12 to 18 months after the transaction, and it quickly can become a disconcerting and disorienting experience.
The resulting "motion sickness" can evidence itself in various ways, such as deteriorating employee confidence in the leadership, low morale, higher turnover and absenteeism and a general malaise triggered by a lack of purpose and direction.
As a consequence, the new public entity resulting from an IPO or spin-off may not fully realize the potential of its human capital. But human resource executives, working strategically with the company’s leadership, can dramatically smooth the emotional highs and lows of a wild IPO ride and help corporate performance meet expectations.
One reason roller coasters are scary is that their designers purposely distort or hide riders’ line of sight to the track ahead. This creates an incongruity between what riders see and expect to happen and what actually occurs. To reconcile this incongruity, employees of IPOs need the information to "see" the track ahead and to align their expectations with reality. This alignment will enhance their readiness and sustain their willingness to contribute to the company’s success as a freestanding entity.
Three steps, when thoroughly and thoughtfully executed, help dramatically tame the wild IPO ride.
Step 1: Know What (Probably) Lies Ahead and Spread the Word
Before an IPO or spin-off, the traditional focus of corporate leadership has been on the dollars and cents of the deal. Beyond the assumed attraction of stock option grants, many companies dedicate minimal resources and attention to the transaction’s "people" issues. There are very few "HR moments" on the pre-transaction agenda.
Many companies do little to clear the "track" ahead and address the potential incongruity between employees’ expectations and post-transaction reality. By the time these organizations get to the "people stuff," the transaction’s roller coaster ride is well under way and "motion sickness" has set in.
As one high-tech company learned, corrective medicine was costly and ineffective because it was administered too late.
At the IPO of this profitable business, all employees were granted stock options. However, beyond the charismatic CEO’s initial hype, employees were provided little information about the new company’s direction, about their "ownership" in the company or about how the operational imperatives of the new public entity might affect them.
When the first quarter’s earnings did not meet analysts’ expectations for a high-tech company, the stock price dropped to half the IPO price. Employees wondered, "What does all of this mean for me?" The CEO’s actions and answers were inconsistent with the reality employees experienced. Accelerating turnover harmed the company’s ability to serve clients and secure new ones. A "quick fix" of more stock options did not stem the exodus or improve morale. Eventually, a "fire sale" to a competitor returned less than half the investment made by the company’s initial shareholders. (Some details about companies cited in this article have been changed to preserve client confidentiality.)
Increasingly, HR executives are seeking to minimize the risk of negative performance consequences when going public. They try to better define the "track" ahead and align employees’ expectations or assumptions with the company’s business mandate as a public entity.
To play a prominent role in a company’s pre-transaction agenda, HR must be prepared with respect to managing the human capital issues. This preparation allows the executive to actively seek and act upon "HR moments" that link people and business imperatives.
One HR executive of a now publicly traded manufacturing company exemplified this preparedness. Before the IPO, she obtained from the chief financial officer a copy of the investment banker proposal presentations. She became familiar with the "positioning" proposed by the bankers and noted the names of companies the bankers considered "comparables."
The executive assigned each HR staff member to research specific aspects of at least one comparable company’s experience before and after going public. The track ahead was researched through publicly available documents such as compensation committee reports in proxies, government filings, news stories, Internet searches, company web sites and, especially, the Securities and Exchange Commission’s EDGAR database (www.sec.gov). Information gathering was followed by phone interviews with senior HR professionals at the comparable companies, which focused on identifying lessons learned during the transaction, critical success factors and disappointments. Completed homework assignments included five sets of facts about each company:
Business perspective. What is the company’s business mandate and how does this translate into its business strategy? Its compensation strategy? How are these strategies reflected in the design of the reward program?
Investment analyst perspective. What did market analysts predict about the company before the transaction? What were they saying about the company six to nine months later? Why?
The market’s perspective. How has the stock price moved since the transaction? Has stock price been a good indicator of actual financial performance?
Employee perspective. What’s going on with employees (e.g., "business as usual" turnover, layoffs, labor disputes, breakthroughs)? What are the successes? What are the lessons?
Employee ownership perspective. How did the company use equity vehicles at the time of the transaction? How far down in the organization were option grants made? What vehicles were used? What levels of grants were made? To whom? What is the company doing on an ongoing basis? What else did the company do to create employee "ownership?" (For more about stock options, see "Alternatives for Stock Options," HR Magazine, January 1999.)
One of the key lessons garnered by this manufacturing company was that, in its industry, employees at all levels anticipated that they would get rich through large option grants that would appreciate quickly in value. The companies studied did not have enough options available to meet this expectation. Perhaps worse, the post-transaction stock price had not grown as anticipated. The almost universal recommendation was to find other non-equity vehicles to create a sense of "ownership."
Very early in the pre-transaction period, HR concisely summarized the homework findings (see "Track Ahead Summary," below). When the HR executive, armed with the data gathered, was asked to work with the leadership group to resolve the stock option issue, she turned its focus from a quick fix of 50-options-for-everyone toward an articulated position on four key issues: "What’s our business strategy? What kind of behaviors must be reinforced to achieve this strategy? Will direct employee ownership in a volatile stock have positive or negative impact on these behaviors? Is there another way to engender a sense of ownership and reward for the employee behaviors and results we seek?"
Recognizing that stock appreciation might lag achievement of critical internal measures of success, company leaders used the annual incentive plan to keep morale up and keep employees focused on critical actions to fulfill business mandates. Matching contributions in the 401(k) plan were made in company stock, company stock was offered as an investment opportunity in the 401(k), and a discounted employee stock purchase plan and recognition program offering stock awards were adopted.
As a result of this planned approach, "motion sickness" was minimal at this company, both before and after going public.
Step 2: Articulate the Business Mandate and Act on Its Implications
Every IPO and spin-off clearly separates a known past from a potentially exciting future that is uncertain, unpredictable and publicly visible. á Experience suggests that companies that successfully have cleared employees’ line of sight to the track ahead had few illusions about the future. These companies did not mistakenly assume that the pre-transaction business mandate and operational plans would suffice for a freestanding entity.
Companies that successfully tame the IPO ride engage their leadership group in a rigorous, candid evaluation process of the "outsider looking in." Before the transaction, these companies evaluate the track over which they have traveled, make adjustments to the proposed post-transaction track and then broadly communicate the conclusions and implications of their evaluation.
Five key questions frame such an evaluation:
What is our post-transaction business mandate?
How will we display successful achievement of the mandate (e.g., sustainable revenue/profit growth, productivity improvement and strategic investments in new opportunities)?
What does success look like to each of our stakeholders—investors, customers, employees and the wider community?
What strategy, culture and employee behaviors will lead to the success our stakeholders demand?
What messages concerning the design and focus of our current employee programs might obstruct the track ahead? How do we remove the obstructions?
The "outsider looking in" evaluation requires that the cynics’ view be considered in answering each of these questions: "And what could go wrong? What aren’t we facing up to in our answers?"
This evaluation process was successfully executed by a multibillion-dollar Rust Belt business spun off from a high-growth, glamorous company. The spin-off would have a negative net worth and more than $1 billion in debt. Undaunted by these challenges, the corporate leadership team took a careful "outsider looking in" approach to its pre- and post-transaction activities.
During the year before the spin-off, the executive team took several critical actions. It 1) defined and honestly discussed with analysts and all employees the post-transaction business mandate and the company’s strategy to overcome the challenges it would face; 2) identified the cultural and behavioral attributes needed to align with the mandate; 3) completed considerable homework about what happened at similar spin-offs in the same industry and broadly shared the findings; 4) assessed all employee programs for fit with the post-transaction business mandate, strategy and culture; 5) communicated the rationale behind planned changes and tied post-spin-off incentive plan payouts and stock option vesting to measures that would focus employees on the business imperatives; and 6) made all employees educated "owners" through a stock option grant accompanied by clear communication about the realities of stock price fluctuations in the industry sector.
During the year following the spin-off, this company kept the track ahead unobstructed. Leadership focused on implementing its business strategy and continued its information gathering and sharing. There was little disparity between what employees expected to happen and the realities of the post-transaction period.
By the end of the first year analysts were scratching their heads and asking, "How did they do it?" Debt had been reduced on an accelerated basis, the company’s total return outperformed industry indices, and its stock price gain outpaced that of its former parent. Despite significant peaks and valleys in the stock price shortly after the transaction, the workforce experienced little turnover and was openly proud of its role in the company’s achievements.
Step 3: Boldly Face and Communicate the Facts Before And After the Transaction
As illustrated by the example of the failed high-tech IPO, a lack of candor and openness about the track ahead exacerbates the motion sickness that can cause the performance of a newly public entity to fall short of expectations.
The leadership of that company was reluctant to broadly share the facts about the track ahead and to reconsider the messages sent by their employee programs. Both before and after the transaction, the leadership feared that investors, customers and employees would flee.
The lack of candor demonstrated by this company resulted in the very outcome it sought to avoid. But more successful experiences suggest that companies can tame the going-public roller coaster ride by boldly facing the facts and candidly addressing them. This was a key element of the success of the Rust Belt spin-off described in Step 2.
Before going public, many organizations are diligent about candidly communicating the facts about the track ahead. However, the diligence wanes after the transaction, with the predictable negative consequences of "motion sickness." Post-transaction, the track ahead starts taking unexpected twists and turns over which the company seemingly has no control.
Prominent among those uncontrollable factors is the fluctuation of the stock price. The ups and downs may have little linkage to the company’s progress in fulfilling its business mandate or economic prospects. But unfortunately, stock price often is how employees measure company success. If the price is up, the company is a "winner"; if the price is down it is a "loser." Employees want to be associated with a winner and, especially in newly public companies, they want to realize their dream of getting rich on options. When the stock price declines, particularly in companies that granted broad-based options, employees feel like "losers," and morale and performance may decline, as in the example of the failed high-tech IPO.
The temptation is to make "excuses" and, as a consequence, to leave employees without guidance on how to realign expectations with the reality they are experiencing. For example, one senior executive in a company that had recently gone public tried to explain to employees why the stock price was half the IPO price. In a memo to all employees, she constructed a cogent argument that the vagaries of the marketplace had caused the precipitous drop in stock price (the company was an out-of-favor "small cap"; it was not a hot "dot-com" stock; the industry was out of favor among investors). She counseled that patience and belief in the company were the keys to increasing the share price.
No one could fault her logic. But the executive failed to provide additional facts about the shortfall in meeting investor expectations. Between the first two quarters of the company’s current year, sales had risen less than 3 percent and profit was essentially flat. The memo did not identify where and how improvements could be made, nor exhort everyone to participate in the effort. Employees’ expectations were not aligned with reality, nor were they empowered to influence that reality. As employee anxiety and speculation increased, the stock price stagnated.
Pre-transaction companies, like the manufacturer in Step 1 and the Rust Belt spin-off in Step 2, face such predictable obstacles as stock fluctuations head on. Before the transaction they advise employees what to anticipate. Some of the data for the communications are derived from the stock performance history of the peer group researched by HR. Among the observations frequently supported by this research and shared with employees are:
There is no real pattern in terms of timing and stock price. At any given time, a newly public entity could have a rising or falling price.
Top performers also have sharp declines.
Nearly every stock experienced both a large increase and a large decrease in price during its first two quarters of public trading.
These companies also explain specific factors that may have caused the peaks and valleys in the stock prices of the peer group (such as the company introduced a new product; a competitor entered the market with a better product; the company announced stronger-than-expected earnings; the Food and Drug Administration did not approve a product). These explanations prepare employees to understand how company performance, investor expectations and the competitive venue may influence the stock price of their company when it goes public. While such pre-transaction preparation does not eliminate post-transaction employee concern about stock performance, it does moderate employee anxiety (as well as euphoria) at each blip in the stock price.
The pre-transaction employee preparation establishes a platform upon which to build candid, ongoing communication after the transaction. The company, rather than the internal and external rumor mills, will be the credible source of information about events to come. It also prepares employees to look objectively at stock price fluctuations and encourages employees to seek out opportunities to make or keep their company a winner.
With these strategic techniques, the roller coaster ride of going public can be tamed. HR can help moderate the motion sickness with a candid discussion of the track ahead and with delivery of consistent strategy, culture and behavioral messages. The result will be that employees can align their expectations with reality and anticipate how they can contribute to the company’s success.
Myrna Hellerman, a principal in the Chicago office of Sibson & Co., is an expert on the human capital management and performance challenges precipitated by major financial transactions such as IPOs, spin-offs and mergers. Before joining Sibson, she was the chief HR executive for Hyatt Corp.
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