I bookmarked this site years ago regarding PIPE's - it is from 2002 but it has a pretty detailed description:
PIPE transactions http://www.altassets.net/private-equity-knowledge-bank/learning-curve/article/nz2856.html 23 Jul 2002. Source: Testa, Hurwitz & Thibeault. Michael A Conza The turbulence of the public markets over the last couple of years has led many investors and companies to look at PIPEs (Private Investment in Public Equity). It does, however, have some pitfalls. Michael A Conza of Testa, Hurwitz & Thibeault gives an overview of PIPEs and discusses some of the structural issues that should be considered by investors.
In a PIPE transaction, investors purchase securities directly from a publicly traded company in a private placement, typically at a discount to the market price of the company's common stock. Because the sale of the securities is not pre-registered with the SEC, the securities are ‘restricted' and cannot be immediately resold by the investors into the public markets. Accordingly, the company will agree as part of the PIPE deal promptly to register the restricted securities with the SEC. Thus, the PIPE transaction can offer the company the speed and predictability of a private placement, while providing investors with a nearly liquid security at a discount from the current trading price.
PIPE flavors
PIPE transactions come in many varieties - differing on the basis of the structure and terms of the deal, the securities offered, and the investor base.
‘Pure PIPE' vs ‘Standard PIPE.' In a ‘pure' PIPE, investors agree to purchase the company's securities in a private placement on the condition that a registration statement for the resale of those securities is declared effective by the SEC immediately after the closing of the private placement. The closing of the pure PIPE transaction, therefore, is delayed until the effective date of the registration statement, giving investors the immediate ability to resell the securities purchased in the PIPE. Due in large part to the legal concerns raised by this structure, a number of investment banking firms will not undertake these pure PIPE transactions.
In contrast, a ‘standard' PIPE transaction is structured so that the private placement of the securities is closed not only prior to the effectiveness of the resale registration statement, but also prior to the filing of such registration statement with the SEC. The company agrees in the PIPE documents to file for the registration of such securities promptly following the closing (typically within ten days of the closing) and to use its best efforts to obtain effectiveness of the registration statement (generally within 30 days of the filing). However, depending on whether or not the SEC opts to review the registration statement, the resale registration process can take several months to complete. Due in large part to this period of illiquidity, investors typically purchase their PIPE securities at a discount to the public market price.
Securities issued. Although various types of debt and equity securities, as well as more exotic securities such as derivatives, can be sold and registered with the SEC in a PIPE transaction, most PIPEs involve the issuance by the company of common stock, convertible preferred stock or convertible debt. As an inducement to complete the PIPE financing, investors also may require warrants as a ‘sweetener.' Warrant terms vary widely, but typically include an exercise price set at a premium to the current market price.
Traditional. The majority of ‘traditional' PIPEs involve the sale of common stock at a fixed price that reflects a set discount (generally five per cent to 15 per cent) from the current market price of the company's common stock. However, traditional PIPEs may instead consist of the sale of preferred stock which, at the investor's election, is convertible into common stock at a fixed conversion price. Such preferred stock may entitle the investors to dividends and other rights and, in a sale, merger or liquidation of the company, will provide the investor with the right to receive back the purchase price of the preferred stock prior to any distributions to the holders of common stock. These benefits can be argued to off-set the illiquidity discount applicable to traditional common stock PIPEs, and therefore traditional preferred stock PIPEs are often priced at or near the current market price of the company's common stock.
Structured. In a ‘structured' PIPE, the company will sell preferred stock or debt securities which, in either case, are convertible into the company's common stock. The conversion price in a structured PIPE, however, is either variable or contains a re-set mechanism that automatically adjusts the conversion price downwards (ie, allows the investor to acquire more shares) if the market price of the company's common stock falls below the conversion or re-set price fixed at the time of issuance. Structured PIPEs provide price protection to investors but subject the company's common stockholders to the risk of significant dilution. Additionally, a structured PIPE transaction may require shareholder approval prior to the issuance of the PIPE securities. In 2001, according to industry surveys, approximately 23 per cent of all PIPE transactions (representing only ten per cent of dollars raised) were structured PIPEs.
The ‘Death Spiral' PIPE. 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.
Investor base
PIPE deals are marketed and sold to a wide range of investors, largely depending upon the type of PIPE (eg, pure vs standard, traditional vs structured), the size and industry of the company and the quality of the placement agent, if any, involved in the transaction. Historically, PIPEs were not sold to traditional private equity investors, but rather to sophisticated public market investors focused not only on the fundamentals of the company but also on the technical aspects of public market investing dynamics, such as trading volume, float and volatility. These investors generally do not seek board seats or special approval rights and, apart from their right to a resale registration, are content to be treated as ‘outside' investors.
Recently, a growing number of traditional venture capital firms have made investments in PIPE transactions. Although many of these investments have been structured in a fairly straight-forward manner, it is not uncommon for venture capitalists to attempt to transpose to the PIPE arena the full-blown rights and protections that they typically seek with respect to private company preferred stock investments. Often, such ‘venture capital PIPE' investments will raise a host of issues under the federal securities laws, corporate laws and the Nasdaq rules. Venture capital firms should also carefully review their partnership agreements to determine whether or not an investment in a PIPE transaction is permissible.
Doing the deal
A significant advantage of PIPE transactions over traditional public offerings is that they can be completed rapidly - typically two to three weeks from kick-off to closing. In a typical PIPE transaction, due diligence is limited in scope because of the compressed time frame, and generally consists of a review of the company's filings with the SEC and press releases and investigative conference calls with the company's management, counsel and accountants.
The documentation for a PIPE financing is relatively minimal: typically consisting of an offering circular summarising the terms of the financing and containing a description of the business of the company taken directly from the company's filings with the SEC, a purchase agreement, a registration rights agreement, an investor questionnaire, a legal opinion from company counsel and, in the case of a convertible preferred stock offering, a certificate of designations or charter amendment defining the rights and privileges of the preferred stock.
After the closing of the financing transaction, the company and its counsel prepare and file the registration statement to register for resale by the investors the common stock issued (or issuable on conversion of preferred stock or other securities issued) in the PIPE. Typically, the registration statement is filed within ten days after the closing, and the company is required to use its best efforts to have the SEC declare the registration statement effective within thirty days after the filing. The SEC may elect to review and comment on the registration statement, which could delay the effectiveness past this 30-day commitment. Once the SEC is satisfied with the registration statement, it will declare it effective and resales of the PIPE securities may begin. The company must keep the registration statement up to date during the entire time that PIPE investors are reselling their restricted securities pursuant to the registration statement.
Michael A Conza is a partner at Testa, Hurwitz and Thibeault, LLP.
This article is reproduced with permission of Testa, Hurwitz & Thibeault, LLP. For more information about Testa, Hurwitz & Thibeault, LLP, please contact www.tht.com
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