‘Death Spiral' PIPES If improperly structured, PIPE transactions have the potential for significant shareholder dilution. Such ‘toxic' transactions typically involve a convertible security with a conversion price that is linked, often at a discount, to the market price of the company's common stock at a discount to the current market price, the discount provides a built-in economic gain, which creates the incentive immediately to sell the securities purchased instead of holding them. As the company's stock price drops, the company is required to issue more stock under the terms of the PIPE transaction. These additional issuances cause further downward price pressure, and the price of the common stock often enters a ‘death spiral.'
The effect of toxic financings is hastened by their unpopularity with institutional investors. Institutional investors are wary of the extreme dilutive effect on the holders of common stock and the historically inevitable decline of their own investments as a result of toxic transactions. Merely announcing a PIPE transaction that does not sufficiently limit the ultimate dilution suffered by current stockholders can negatively impact the company's stock price as existing investors attempt to sell their positions before the results are manifested.
Today, management of very few public companies are willing to commit to a “Death Spiral” PIPE, unless they have desperate capital needs that can’t be achieved otherwise.
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