PIPE Transactions: A Growing Source of Private Financing
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A PIPE, or private investment in public equity, is a private placement of securities in a public company. This investment opportunity is only available to accredited investors, deemed to meet certain qualification standards as defined by the Securities and Exchange Commission (SEC). Historically, investors have used this type of financing in difficult credit environments. It was an alternative financing source when other sources had dried up. Today, PIPEs are used in a broader range of contexts. These contexts include in connection with blank-check companies, or SPACs (special purpose acquisition companies).
In these transactions, the public company may sell common stock, convertible preferred stock, convertible debentures, warrants, or other equity-like securities to PIPE investors. As many as desired PIPE investors that can participate in a given transaction so long as they are accredited.
Pros and Cons of PIPE Transactions
From the perspective of both issuers and investors, there are a number of distinct advantages that make private financing a sound choice.
For the public company issuer, PIPE transactions come with lower transaction costs compared to other types of public offerings. Additionally, the issuer is under no obligation to disclose investor negotiations until there is definitive agreement. This confidentiality helps prevent the negative consequences that could arise if negotiations failed with certain investors.
PIPE investments can be a lucrative opportunity to acquire securities at a discounted price to the current market price. Although the securities are typically subject to a lock-up period, which restricts resales for a certain period of time, the securities eventually become freely tradeable.
A traditional PIPE involves investors acquiring securities from a public company issuer at a fixed price. In order to effectuate this, the investors enter into private purchase agreements with the issuer. In a traditional PIPE, a placement agent is usually guides the process.
Non-Traditional (Structured) PIPEs
In a non-traditional PIPE, there is usually no placement agent. Instead, a lead investor typically controls the investment process. Non-traditional PIPEs became more popular following the 2008 global financial crisis.
Elements of a PIPE
The transactions typically involve common stock. Although investors often prefer convertible preferred stock or convertible debt because of the downside protection it affords, most PIPEs are not convertible PIPEs.
PIPEs usually involve some or all of the following features—consent rights, anti-dilution provisions, registration rights, and redemption features.
PIPE investors that make large financial commitments can obtain consent or veto rights over major corporate actions. A certificate of designation can contain these consent or veto rights. An investor might obtain consent or veto power over dividend payments, major acquisitions, affiliate transactions, and the incurrence of debt.
Anti-dilutive features can offer PIPE investors some protection against the dilutive effect of future securities offerings by the corporate issuer. Some anti-dilutive mechanisms include “full ratchet” protection and “broad-based weighted average” adjustments. These methods seek to offer investors some sort of proportional adjustment to reduce the impact of dilution on the value of the securities they hold.
Registration rights cover the resale of the securities offered in a PIPE private placement. SEC rules govern the registration rights process. PIPE transaction retulst in the receipt of restricted securities. This means that in order for an investor to sell or liquidate their shares, they must first become registered under an SEC registration statement.
Requirements to be an Investor
In order to participate in a PIPE transaction, an investor must be an accredited investor. Accredited investors are often institutional investors, such as mutual funds and hedge funds. Individuals can also qualify as accredited investors if they exceed certain net worth and income thresholds.
Rule 501 under Regulation D of the Securities Act of 1933 (commoly called the “Securities Act”) governs the number of investors. There is no limit on the number of investors in a given transaction as long as they all are accredited investors.
PIPEs Used in SPACs
PIPE investors play a critical role in validating SPACs. Prior to the SPAC IPO, the blank-check company will enter into separate subscription agreements with each investor. The subscription agreement sets forth the commitment amount and other terms of the PIPE transaction.
SPACs that successfully raise a private financing round from accredited investors are often able to leverage that momentum to raise more money during the SPAC IPO. The PIPE financing component enhances the SPAC’s profile, making others more willing to buy shares of the SPAC once they are listed on the public market.
George Arison, the co-founder of an online peer-to-peer marketplace for buying and selling cars called Shift, firmly believes that “PIPEs are critical for SPACs because they validate the valuation.” A strong showing of interest from PIPE investors boosts demand, especially from long-term investors. Arison states, “the ideal outcome is for the PIPE to be oversubscribed.”
Once the lock-up period expires for the PIPE investors, who were able to buy shares of the company early on at discounted prices, the PIPE investors can sell their securities to other investors. Sustained demand for the company’s shares will enable PIPE investors to generate substantial profits when they sell their securities.