11 Aug 2015
PRIVATE INVESTMENT IN PUBLIC EQUITY (PIPE)

by veristrat

Capital is one of the key components which contributes towards successful operations of a company and helps them fuel their growth plans thereby capital raising process assumes a significant place in business operations. However, generally small and mid-sized public companies face significant impediments while raising capital as some of the players do not possess the same level of access to capital markets as compared to their bigger counter parts. Hence, a popular financing technique “PIPE” – Private Investment in Public Equity comes to their rescue.

pipe

A PIPE transaction is basically a form of financing whereby private placement of equity securities takes place for a public company. Hence, additional shares are issued under an agreement usually at discount to current market prices. This route is usually resorted when equity valuations have fallen and the company is searching for new cheaper sources of finance. In this way, capital is accessed in faster mode while increasing institutional investment and boosting public float of securities.

TYPES OF PIPE

PIPEs are either common stock or securities that will convert to common stock, thereby displaying differentiated characteristics which affect the investor’s exposure level to changes in the underlying value of a company’s equity. As PIPES can be accommodated to include additional terms such as caps, floors, redemption provisions and trading restrictions etc. these can be designed in a way such that they limit investors’ downside exposure or can increase upside potential as per the post-issuance stock performance. Hence, these can be classified into two types:-

Traditional/Unprotected PIPE- In this common stock is issued to investors at a discount to current market price. And sometimes, the transaction is accompanied by issuance of warrants which enables the holder to purchase additional shares at a price equivalent to or at premium to the current market price offering investors an enhanced upside potential.

Structured/Price Protected PIPE- In this an investor invests a fixed amount to purchase convertible security (debt or preferred stock) which converts into common stock based upon a schedule at a price equal to the issuer’s current stock price at that time. Thus, the shares received upon conversion will be marketable. If the stock price of the issuer falls, the investor receives more shares and if the stock price of the issuer rises, conversion takes place at the original agreed contract price. However, if the stock price drops below some minimum price investors often have the right to expedite the conversion of the remaining unconverted amount, hence offering investors downside protection.

RISKS

As PIPEs transactions have grown rapidly, they have become a favoured choice of short-term arbitrage investors as the bets are based on the market mechanics. They generally resort to “short-selling” technique whereby they “lock-in” profits on the transaction because of the difference between the market price of the stock and the discount offered to these investors. After booking the profits on the transaction the investor is free to hold warrants for the underlying upside potential being offered by the stock. However, sometimes this “short selling” can turn disastrous for the issuer as this technique creates downward pressure on the price of the issuer’s stock projecting unstable outlook for the security. Therefore, PIPE securities should be offered selectively to investors with long term perspective as some investors may not participate due to the presence of short-term arbitrageurs looking for quick gains.

BENEFITS

Although every mode of capital raising have their own risk characteristics, PIPE serve the needs of both issuer and investors in the below listed ways:-

• Saves issuer from the intricacy of fresh public issue and investor’s gets huge chunk of shares;
• Provides opportunities to invest directly in emerging growth companies;
• Pricing is certain for both the parties as deal has been pre-negotiated;
• Less equity is diluted for the issuer company and also the anxiety of under subscription is eliminated;
• Provides structural flexibilities allowing investors to negotiate various advantageous provisions;
• Provides leverage over competitors as capital raising information is kept confidential.

Hence, a PIPE transaction benefits both issuer and investor as public companies may find this alternative as a more attractive form of financing, however, investors need to be cautious to understand the companies motivation for raising funds.

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