In the midst of what we have come to know as the “global economic crisis,” credit markets continue to be frozen and, in understatement, equity markets continue to be volatile. Failing a substantial near-term recovery, any meaningful window for underwritten public offerings will remain closed. The question that many public companies are asking is what, if any, alternatives are there to raise cash?

Private investments in public equity, commonly referred to as PIPEs, are one option. Once used almost exclusively by small cap issuers or issuers who historically had not been able to sell securities to the public, today large, well-seasoned issuers are turning to the PIPEs market. Indeed, both General Electric Company and the Goldman Sachs Group issued a combined total of $8.0 billion to Berkshire Hathaway Inc. in the fourth quarter of 2008 in PIPEs transactions.[1] Mainstream hedge funds and private equity funds are now opportunistically looking at PIPE investments in distressed companies. Competition in these markets is increasing. Depressed valuations are offering investors attractive opportunities to invest in companies with the potential for future growth.

PIPEs, Deconstructed
What is a PIPE? A typical PIPE is a transaction where one or more investors purchase securities directly from a public company in a private placement rather than in a transaction registered with the Securities and Exchange Commission (SEC). Often, these transactions are conducted through an investment bank or other placement agent, but more recently a greater volume of PIPEs are being sold without an intermediary to one or few large investors. Since PIPE securities are purchased in a private transaction, they are considered “restricted securities” and cannot be immediately resold into the public market. In the transaction, the issuer agrees to file a resale registration statement with the SEC promptly after the closing of the financing. In this way, illiquidity is mitigated—once the resale registration statement becomes effective, the investor may immediately sell the securities purchased in the transaction (or issuable upon conversion in the case of convertible preferred stock or debt) in the public markets. This structure allows for speedy access to capital, a key attraction of a PIPEs transaction to issuers. PIPEs also provide issuers with lower transaction costs as compared to a traditional public offering.

Specifically, in a PIPE transaction, an issuer is contractually required to prepare and file a resale registration statement with the SEC promptly following the completion of the private placement. Typically, a registration rights agreement requires that the issuer use it best efforts to have the registration statement filed with the SEC within 30 to 45 days of closing and declared effective within 90 to 120 days of filing. Registration rights agreements typically contain penalty payments of 1% to 2% of the principal amount of proceeds per month if the issuer fails to meet the filing deadlines. Once the SEC declares the resale registration statement effective, investors may sell the PIPE securities in the public market. The registration statement must remain effective, and the issuer is required to update the registration statement for any material changes, during the period in which the investors are reselling the securities.

Registered Direct PIPEs
Issuers with existing effective shelf registration statements may find PIPEs transactions even more attractive. In a “registered direct” PIPE, an issuer sells securities directly from its shelf registration statement to one or more private investors in a transaction not involving a public offering. As in typical PIPEs, the time to closing may be quick. However, in a registered direct PIPE, investors do not receive “restricted securities” as they are purchasing the PIPE securities in a registered transaction. Unless the investor would be deemed an affiliate of the issuer, there is no need to file a resale registration statement with the SEC following the closing of the transaction. Indeed, this is an attractive option for issuers as not only are transaction costs even lower, the elimination of liquidity risk allows for more attractive pricing. Note, however, that the existing shelf registration statement must already cover the PIPE securities being offered (including any warrants) and the plan of distribution in the base prospectus must contemplate such private sales. In addition, as in all PIPE transactions that utilize the resources of an investment bank to place the securities, the investment bank does not act as an underwriter in an offering. Even though the PIPE securities are offered and sold from an issuer’s existing shelf registration statement, the investment bank acts merely as a placement agent and the transaction is not a firm underwriting.

PIPE Terms
The terms of PIPEs deals vary widely from deal to deal and can involve the offering of a number of different types of securities such as common stock, preferred stock, convertible preferred stock, convertible debt and warrants or any combination of these securities. Typically, PIPE securities are sold at a discount to the trailing average market price for some period prior to closing. However, this is highly negotiated and convertible PIPEs have been priced higher than current market value, especially if there is a conversion premium attached to a convertible security or the security includes warrant coverage.

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