The shutdown in economic activity across a wide range of industries as a result of the COVID-19 pandemic has put severe financial pressure on many public companies. In many cases, this will result in the need to raise additional capital. Public companies have several options for raising primary capital. One transaction that can be effected relatively quickly, and that has become more mainstream over the last decade is a Private Investment in Public Equity (PIPE).
PIPE proceeds averaged well over $40 billion a year from 2015 to 2018, and we expect that the structure will continue to garner favor as issuers and investors navigate the capital markets in the wake of the global COVID-19 crisis.
In a standard PIPE transaction, an issuer will sell securities at a fixed price in a fixed amount to accredited investors. The most common forms of securities sold include:
The transaction permits an issuer to raise capital quickly and without requiring public disclosure that a transaction is imminent, which could have a material adverse effect on the stock price. A PIPE allows the issuer to test the market to gauge potential demand and determine price sensitivity, prior to public disclosure and without having to bear meaningful upfront costs associated with more traditional registered offerings. The sale is typically conditioned upon the filing of a resale registration statement, and approval by the SEC who will then declare that registration effective. Once the registration is effective, the purchasers of the securities are then free to sell the securities in the open market, subject to certain blackout periods.
According to a Harvard Law Review Forum on Governance from November 2017 titled “The Economics of PIPEs,” from 2001-2015, covering 3,001 common stock PIPE transactions by companies listed on the NYSE and NASDAQ, the median PIPE offering represented 9.1 percent of the market value of a company, with 80.9 percent of the transactions being unregistered. The average discount to the closing market price was 6.3 percent, with 39 percent of the transactions including warrants.
A wide range of accredited investors have entered into PIPE transactions, including institutional asset and mutual fund managers, hedge funds, sector funds, pension funds, venture funds and private equity funds. Each type of investor may have different motives for entering into a transaction and it is important to understand the intent when considering doing a PIPE with a new or existing shareholder. Venture and private equity investors may ask for additional covenants in the purchase agreement relating to governance rights and information rights. Your placement agent and your advisor will work with you to confidentially target the right potential investors based on your goals and your timeline.
One of the key advantages of a PIPE in times of uncertainty is that the investor bears the price risk from the time of pricing (when the agreement is executed) through the time of closing (when it is funded). The issuer has no obligation to deliver additional shares based on stock price fluctuation. Secondly, an issuer only needs to publicly announce the transaction when a definitive purchase agreement has been executed. Typically, potential investors will not receive any material non-public information and will rely on public filings for their diligence. Lastly, a transaction can happen quite quickly, typically within 7-10 days of the purchase agreement being executed.
Issuers will engage one or more private placement agents, and may work with a capital markets advisor to shepherd the process. Once a purchase agreement is signed, the issuer is usually required to file a resale registration statement (usually an S-3), covering the resale of securities from time to time by the holders. Under those circumstances, the transaction closes once the SEC indicates its preparedness to declare that statement effective, and funds/securities are exchanged. The resale registration statement is effective until those shares may be sold free of restrictions under rule 144a. Usually, the issuer cannot issue more than 20 percent of its total shares outstanding at a discount without shareholder approval and prior notification to exchanges, although there has been some recent discussion around relaxing that rule in the wake of the current crisis. There may be other restrictions if the issuer has completed other private transactions within a six-month period.
While a PIPE may sometimes be modestly dilutive to current shareholders, it also can mute some of the market impact of a primary offering versus traditional marketed offerings in periods of distress and volatility. In a traditional marketed primary equity offering, the announcement of an intent to raise primary capital can lead to a meaningful decline in the company’s stock price, and cause some existing holders to make short-term decisions to decrease or exit their position.
Public companies have several options during periods of crisis, but often don’t have the luxury of time as they might during normal conditions. It is important to get informed and unbiased advice from advisors that have the experience of advising and investing through previous market cycles. To learn more about ICR and our capital advisory services, please contact us.