A PIPE transaction, or a private investment in public equity, can be an efficient method of capital raising. It involves a private placement of securities of a publicly listed company. The benefits of PIPE transactions include marketing to a select group of investors, flexibility to tailor transaction terms, and a due diligence process that is narrower in scope compared to other financing transactions.

The securities offered in the PIPE transaction can be common stock, warrants, convertible or non-convertible preferred stock, or convertible notes. This article will focus on PIPE transactions that involve convertible preferred stock.

The key legal documents in a PIPE offering involving convertible preferred stock include the investment agreement, the certificate of designations, and the registration rights agreement. There may also be a voting support agreement entered into between certain significant investors and the company.

The preferred stock investors may be granted a number of key rights such as anti-dilution rights,board representation rights, information rights, preemptive rights, voting rights, and conversion rights. Key restrictions may include standstill restrictions, transfer restrictions, minimum holding periods, and limitations on hedging transactions.

If the preferred stock is convertible, the conversion price is usually set at a fixed amount that represent a premium to the market price of the company’s common stock. For example, the conversion price per share might be set at a certain percentage premium above the 20-day volume-weighted average price (VWAP) of the company’s common stock ending a couple days before the deal signing date. The convertible preferred stock is subject to anti-dilution adjustments for events such as stock splits.

Convertible preferred stock comes with mandatory and/or optional conversion features. If the convertible preferred stock has a mandatory conversion feature, the mandatory conversion is often triggered when the company’s common stock exceeds a certain percentage of theconversion price over a specified number of trading days. Optional conversion provisions allow the preferred stockholders to convert their preferred stock into shares of common stock after a specified date or if the company’s common stock trades above a certain level.

Transfer restrictions protect the company by limiting the ability of holders to freely transfer their preferred stock. In particular, the transfer restrictions may prevent the preferred stock from being transferred to competitors or activist investors.

The registration rights agreement will provide the investors with the right to have their shares of preferred stock or the underlying common stock registered. The resale registration rights enable investors to freely sell their shares, subject to customary limitations.

The investment agreement will typically include a provision regarding the reimbursement of expenses. The company will often be obligated to cover the expenses of the preferred stock investors, subject to a cap. The investors may also be entitled to a transaction or commitment fee.

The company may impose standstill restrictions on investors. Standstill restrictions prevent holders from launching proxy campaigns, engaging in shareholder activism, pursuing a hostile acquisition of the company, or buying more shares of a company beyond an established threshold.

Some significant holders of preferred stock with ownership exceeding a certain percentage may be entitled to appoint a director to the company’s board. The board appointment right may fall away if the holder’s ownership decreases below a specified threshold. Some companies may only provide observer rights to significant holders of preferred stock. Board observers may attend board meetings and has access to board-level information, but do not have voting rights like directors.