Private investments in public equity, also known as PIPEs, enable both smaller and larger companies to raise capital on a shorter timeline, and more confidentially, often with fewer transaction costs than with a traditional underwritten public offering. PIPEs, in turn, offer investors such as hedge funds and private equity investors the opportunity to tailor an investment in a public company that has both downside protections and upside rewards.
In a PIPE transaction, a public company issues securities to one or more accredited investors in a private placement exempt from registration pursuant to Section 4(a)(2) of the Securities Act of 1933, as amended (the 'Securities Act’), or the safe harbour thereunder provided by Regulation D under the Securities Act. Because the securities in a PIPE offering are initially ‘restricted securities’ within the meaning of the Securities Act, investors cannot freely resell their securities until a holding period under Rule 144 under the Securities Act has lapsed or a registration statement filed with the Securities and Exchange Commission (the ‘SEC’) for the securities becomes effective. PIPE transactions often include a registration rights agreement whereby the issuer agrees to file a registration statement with the SEC within an agreed-upon period after the offering has closed.
The type of security varies, but typically includes common stock, warrants, preferred stock, convertible notes or a combination. PIPE offerings are highly negotiated, so depending on the circumstances, the terms of any PIPE offering can vary widely. Set forth below is a brief overview of some key considerations for PIPE offerings.
Potential advantages of PIPE offerings
The key potential advantages of PIPE offerings include:
- Shorter deal time line - Issuers without an effective shelf registration statement can get to market faster with a PIPE offering than a registered offering since they do not have to wait for a registration statement to be filed and become effective before launch;
- Lower transaction costs - Since the investor pool is more limited, marketing costs are lower and issuers can market their securities using streamlined offering materials; and
- Confidentiality - Unlike an SEC registered transaction, PIPE offerings can generally be entered into and completed more discreetly.
Potential disadvantages of PIPE offerings
Some noteworthy disadvantages of PIPE offerings include:
- Stock exchange limitations - Under Nasdaq and NYSE rules, issuers generally cannot sell more than 20% of their outstanding stock in a PIPE offering at a discount without shareholder approval;
- Illiquidity premium - Investors cannot freely resell their securities until (i) the 6-12 month Rule 144 holding period lapses or (ii) a registration statement is declared effective by the SEC; and
- Pricing uncertainty - Unlike an underwritten public offering, PIPE offerings do not generally benefit from a broader book building process to discover a market price for the securities.
Investors typically negotiate for a discount to market price due to the short-term illiquidity resulting from the securities being initially restricted. Warrants (with an exercise period often of five to seven years), however, are commonly included to reduce or limit discounts to the market price by providing additional potential upside for investors.
Typically negotiated terms
Some examples of negotiated terms include:
- Customised interest and dividend provisions - For notes and preferred stock, parties will negotiate whether dividends or interest are cash pay or payment-in-kind (PIK) or a combination, whether they accrue if not paid, whether they step up or down over time and whether they are subject to minimum performance hurdles or caps or other features;
- Put/call events - Investors may seek to negotiate special call or put events;
- Anti-dilution - Investors may seek protection against both economic and voting dilution through adjustments to the exercise or conversion price or the number of shares deliverable on exercise or conversion as a result of certain dilutive issuances. Investors may also seek the right to participate on an as-converted basis in any rights issues or other fundamental transactions where new shares are issued to holders of the issuer’s common stock;
- Participation rights - Investors may seek the right to purchase all or a portion of any subsequent securities offering;
- Change of control or ‘fundamental change’ provisions - In the event of certain fundamental transactions, holders of warrants or other convertible instruments may be entitled to receive the same consideration provided in the transaction or have the right to require the cash repurchase of their securities based on a Black-Scholes or other valuation;
- Cashless warrant exercise - Cashless exercise allows warrant holders to receive the ‘in the money’ portion of the common stock issuable upon exercise without a cash payment by the investor. Because the total number of shares the investor receives is proportionately reduced according to the difference between the market price of the shares at the time of exercise and the exercise price, there is less equity dilution, but the issuer does not receive additional cash consideration;
- Prepaid warrant - Investors pay the exercise price in cash up front (thereby providing immediate liquidity to the issuer) and can exercise for a specified time in the future for no additional consideration;
- Board representation and voting rights - In certain PIPE transactions, investors may negotiate for board representation and/or voting rights for as long as they hold a designated amount or percentage of securities;
- Liquidation preferences - Upon certain liquidation or “deemed” liquidation events, the investor may be entitled to a multiple of its investment prior to distributions to other equity holders stock;
- Restrictive covenants - Issuers may be required to comply with financial covenants during a specified term or as long as the investors hold preferred stock, including limitations on indebtedness, payments, disposals and mergers, as well as maintenance covenants covering working capital and EBITDA or be subject to an event of default;
- Liquidated damages - If the issuer fails to effectuate a registration statement with the SEC within an agreed time frame, investors may require the issuer to make a cash payment to compensate the investors for the loss of their expected liquidity; and
- Most favoured nation (MFN) provisions - MFN clauses may require the issuer to change or offer to change provisions of the securities to the extent that more favourable terms are offered to subsequent investors (e.g., lower exercise prices, more favourable change of control trigger, etc.).
When access to capital is otherwise difficult, PIPE transactions may offer companies the chance to tailor transactions that provide them with much needed working capital in a package that addresses investor requirements.
This memorandum is a summary for general information and discussion only and may be considered an advertisement for certain purposes. It is not a full analysis of the matters presented, may not be relied upon as legal advice, and does not purport to represent the views of our clients or the Firm. The views expressed in this newsletter are the views of the authors except as otherwise noted.
Eric Sibbitt is a capital markets partner in O’Melveny’s San Francisco office. He structures and executes initial public offerings and other complex capital-raising transactions for companies and underwriters, including NYSE and NASDAQ listings, registered follow-on offerings, global offerings, PIPEs and other private offerings, and liability management transactions. Clients turn to Eric for boardroom counsel on SEC and corporate governance matters as well as for his pragmatic approach to navigating the tension between legacy regulations and innovative business models Eric also frequently advises on cross-border public and private company mergers, acquisitions, tender offers, and going private transactions.
Paul Porter is a capital markets counsel in O’Melveny’s San Francisco office. He has extensive experience advising both issuers and underwriters on a variety of Rule 144A and SEC-registered capital markets transactions, including IPOs, high-yield and investment grade bond offerings and liability management transactions. His industry experience includes healthcare, real estate development, commercial banks, soft-drink bottlers, oil explorers, broadcasters, railroads and utilities.
C. Brophy Christensen, Co-Chair of O’Melveny’s Capital Markets and Corporate Finance Practices, is a partner in the Firm’s San Francisco office. He represents issuers, underwriters, and investors in a wide range of public and private equity and debt offerings and exchange offers. These investment transactions include initial public offerings, follow-on offerings, debt offerings, and convertible offerings. Brophy advises companies in a variety of businesses, including those in financial services and banking, life sciences, REITs, semiconductors, electronics, software, entertainment, and telecommunications.
Ke Geng is a capital markets partner in O’Melveny’s Beijing office. He advises Chinese companies in connection with outbound investments and exchange listings in the United States or Hong Kong, as well as the privatization of US or HK listed companies, private equity and venture capital financing, mergers and acquisitions transactions, and general corporate matters. Ke provides client-oriented, proactive, and cost-effective services to companies spanning a wide variety of industries, including healthcare and technology, media, and telecommunications (TMT).
Jaroslaw Hawrylewicz is a partner in O’Melveny’s New York office. He is a seasoned corporate transactional lawyer specializing in capital markets, derivatives, and structured products. Jaroslaw’s practice has a particular emphasis on transactions related to equity and other derivatives, derivatives financing, equities sales and trading, and relevant regulatory, legislative and industry initiatives. Prior to joining O’Melveny, Jaroslaw was the Head of Equity Derivatives & Synthetics Legal Group at Barclays Capital, where he led a team of attorneys dedicated to covering businesses with equity derivatives or synthetic aspects.
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