Open Up the PIPEs: Current Market Considerations

Stephen Amdur and Davina Kaile are partners and Brian McKenna is special counsel at Pillsbury Winthrop Shaw Pittman LLP. This post is based on their Pillsbury memorandum.

Private investments in public equity are likely to become more popular as investors and public companies utilize PIPEs to navigate market turbulence.


Takeaways

  • In the face of tremendous market uncertainty, PIPE transactions offer companies and investors an opportunity to bridge valuation gaps and bolster balance sheets. Accordingly, and as seen in 2007-2009, we anticipate a significant uptick in PIPEs in light of the turmoil created by the COVID-19 crisis.
  • PIPEs offer public companies a quick, discrete and flexible source of financing and liquidity.
  • PIPEs enable issuers and investors to tailor the terms of investment, including financial and governance features, to the goals of the parties.

In periods of market stress and volatility, a company may find itself with an acute need for additional sources of financing and liquidity. Whether to finance existing operations or acquisitions, to refinance existing debt or to build a cushion of available cash in periods of uncertainty, a PIPE (private investment in public equity) transaction offers public companies an attractive source of capital.

Issuers in need of capital and investors looking to deploy funds nimbly are attracted to PIPE transactions—an investment in a private, non-registered issuance of securities in a public company—because they can be done quickly and discretely without disclosure to the market until a deal is signed. PIPEs enable parties to tailor investment terms to their commercial goals and, particularly for the issuer, signal to the market that it is worthy of investment by sophisticated investors. For private equity sponsors and other investors, PIPEs are a way to continue to invest in markets that may be challenging for buyouts and other investment strategies. PIPEs also present investors with an opportunity to take a sizeable position in an issuer at a price that is typically a discount to the prevailing public market price.

During the financial crisis of 2007-2009, there was a notable uptick in PIPE transactions for these reasons and, given current market conditions, there is reason to think PIPEs might again become the investment of choice for issuer and investors.

Key Commercial Terms

While PIPE issuers and investors tailor the terms of the investment to the aims and preferences of the parties, most PIPE transactions include some combination of the following key commercial terms.

  • Type of Security. There is a range of securities issued in PIPE transactions, including common stock, convertible or non-convertible preferred stock and convertible or non-convertible debt. PIPEs may also be done with or without warrants. Convertible preferred stock is an attractive option for many PIPE investors as it is senior to common stock, bears a dividend, and includes a liquidation preference while also having a conversion feature that offers an investor participation in the upside of an issuer’s common equity.
  • Dividends/Coupons. The securities issued in PIPE transactions often bear a dividend or coupon, and this can be payable in cash or payable-in-kind on a cashless basis. Depending on the security issued in a PIPE, an investor may receive certain protective features (e.g., an expanded board appointment right or increased governance rights) if dividends are not paid for a defined period of time.
    • Board Rights. Many investors will negotiate for representation on an issuer’s board of directors proportional to the investor’s percentage ownership interest in the issuer, subject to the investor maintaining ownership above a certain minimum threshold.
    • Consent Rights. An investor may be granted consent rights over certain key corporate actions such as changes to organizational documents and the seniority of the investment security. An investor will also typically vote on an as-converted basis with the issuer’s common stock (subject to exchange limitations, as noted below).
    • A PIPE transaction may subject its investors to a standstill provision restricting matters such as acquiring additional securities, entering voting agreements or otherwise seeking to assert additional control over the issuer.
    • Registration Rights. In general, investors in PIPE transactions require registration of their investment securities to enable them to resell and obtain liquidity in the public markets and because many have internal limitations on the amount of restricted securities they can hold in their portfolios. Accordingly, investors typically negotiate terms governing the registration of PIPE securities, the timing and number of filings of registration statements of the issuer and investors’ ability to demand registration of their securities (i.e., demand rights) and add their securities in other registrations of securities by the issuer (i.e., piggyback rights).
    • Lock-up. Investors in PIPE transactions may agree to a restriction on their ability to sell their investment securities (and attendant governance rights, to the extent transferable) for a certain time period after making the investment. A lock-up may also contain limitations on the size of the block an investor can sell to a future transferee as well as the identity of that transferee.
  • Conversion & Redemption. The securities issued in PIPE transactions (e.g., convertible preferred stock) may have a wide range of conversion and redemption features, including on a mandatory basis or at the issuer’s or investor’s option.
    • Triggering events that permit or require conversion may include the passage of a certain period of time, the issuer’s common stock reaching a specified threshold or, in the case of mandatory conversion, typically a change of control of the issuer. PIPE transactions may also include a “make-whole” feature in favor of the investor upon a change of control of the issuer or upon a notice of redemption.
    • Like conversion features, there are a number of triggering events that may permit or require the redemption by the issuer of the securities issued in a PIPE transaction, and redemption prices may include make-whole or rate of return based features.
  • Anti-Dilution & Preemptive Rights.
    • Investors in PIPE transactions receiving securities convertible into common stock typically receive anti-dilution protection in the event the issuer engages in a stock split, reclassification or other similar act. In addition, in the event of a future issuance of securities at a lower price, PIPE investors often negotiate for broad-based weighted average anti-dilution protection, which takes into account the weighted average dilutive effect of a future equity sale based on the size of that sale.
    • In addition, PIPE investors often negotiate for preemptive rights to participate in future equity sales by the issuer, either by including an express preemptive right or by obtaining a consent right over future equity sales.

Key Structuring Considerations

Issuers and investors considering PIPE transactions should be mindful of a number of key structuring, legal and regulatory considerations.

  • NYSE and Nasdaq shareholder approval rules. In general, both the NYSE and Nasdaq require shareholder approval for certain transactions, including: (a) prior to the issuance of 20 percent or more of a company’s outstanding common stock or voting power (subject to certain exceptions); (b) where the issuance would result in a change of control (generally a fact-specific analysis, but factors include whether an investor acquires 20 percent or more of the outstanding common stock or voting power and whether the investor would have other indicia of control, such as board representation, preemptive rights, or if the investor would hold the largest ownership position post-transaction, even if less than 20 percent); and (c) certain related party transactions (e.g., Nasdaq typically views issuances to directors or officers at less than market value as equity compensation and thus requiring shareholder approval while the NYSE has a specific rule regarding related party transactions). There are various ways to structure around the shareholder approval requirements, including by placing limitations on conversion or exercise until shareholder approval is approved. In PIPE transactions where shareholder approval is necessary, investors often impose negative economic consequences on an issuer if approval is not obtained in a timely manner.

Regulatory Update: On April 6, 2020, the Securities and Exchange Commission approved a waiver of certain limited aspects of NYSE’s shareholder approval requirements in connection with PIPE transactions. The waiver provides a degree of incremental flexibility to NYSE-listed companies conducting PIPEs priced at or above a minimum market price through June 30, 2020. The waiver aligns certain aspects of the NYSE’s rules with those of Nasdaq. The waiver does not, however, apply to the change of control rule. The shareholder approval rules are complex, and a proposed PIPE should be reviewed under all applicable shareholder approval rules, with advance consultation with the applicable stock exchange as appropriate.

  • Restrictions in organizational documents. An issuer should confirm it has sufficient unissued but authorized stock under its charter, taking into account shares reserved for issuance in connection with other convertible securities or under equity compensation plans. In addition, an issuer should confirm its charter authorizes the security being issued in the proposed PIPE transaction (e.g., preferred stock). If shareholder approval is required to amend an issuer’s charter to increase its authorized stock or permit a new type of security issuance, it could significantly delay and possibly jeopardize the transaction. If such approvals are required, they will generally be consolidated with applicable stock exchange approvals to facilitate the shareholder approval process.
  • Restrictions in existing debt arrangements. An issuer should review its existing debt arrangements, including with respect to restrictions on incurrence of debt, use of proceeds, changes of control and related party transactions, to confirm they contain no restrictions on the terms of the proposed PIPE transaction.
  • Hart-Scott-Rodino (HSR). PIPE transactions may require HSR filings (and approvals) if the parties and the transaction meet the applicable filing thresholds.
  • Industry-specific approvals. Depending on the industry of the issuer (e.g., financial services, energy, communications, etc.), a PIPE transaction may implicate industry-specific regulatory notice or approval requirements.
  • CFIUS considerations. A PIPE transaction may implicate CFIUS considerations depending on the identity of the proposed investor, the business of the issuer and the terms of the proposed PIPE. Keep in mind that PIPEs structured as convertible debt may also implicate CFIUS.
  • Pre-existing relationships between the issuer and the investor. Issuers and investors in PIPE transactions should also be mindful of any pre-existing relationships between them. Pre-existing relationships may result in a proposed PIPE being considered a related party transaction and complicate the analysis under NYSE/Nasdaq rules and the issuer’s existing debt arrangements, the corporate law applicable to the issuer and the issuer’s corporate governance policies. In addition, if an investor in a PIPE is already a significant investor in the issuer or has a board seat, it is possible for the PIPE to give rise to conflict of interest considerations, and additional safeguards may be required in connection with the issuer’s approval of the PIPE.
  • Securities law and disclosure considerations. Issuers should confirm Form S-3 eligibility and be mindful of disclosure and Regulation FD considerations. Note that the fact that the issuer is contemplating a potential financing may itself constitute material non-public information about the issuer. Issuers and placement agents should also be mindful of Regulation M, as most PIPEs are considered “distributions” for purposes of Regulation M.
  • Take care with hedge positions. While several district courts have disagreed with this approach, the SEC has previously brought enforcement actions against investment funds for improperly hedging and closing out short positions used to hedge PIPE positions. Companies should be wary of potential hedging strategies by investors which may dampen the potential benefits of the PIPE transaction, and investors should be careful when structuring any short positions to ensure that they do not inadvertently expose themselves to enforcement actions.

As PIPE transactions offer both issuers and investors flexibility and speed, they may be an attractive and compelling option for businesses seeking capital in the current environment, particularly for businesses with urgent liquidity needs. However, a number of pitfalls remain for the unwary, and participants should consult with counsel in advance in order to appropriately structure a PIPE investment.

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