We created PIPE (private investment in public equity) transactions in 1984 to address unmet financing needs.1 While a lot has changed since the first PIPE transaction, much remains the same. PIPE transactions were created to be an effective approach to capital raising for public companies when there were few, if any, other satisfactory financing alternatives. Then, it was very difficult to predict whether the public offering window would be open, stay open at least a crack, or close with little notice. PIPE transactions proved to be particularly useful when the equity markets were quite volatile. The first PIPE transactions were executed by regional bank holding companies, but the PIPE offering methodology rapidly became industry agnostic.

In the ensuing 36 years, both the relevant federal securities regulation, and the major sources of capital, have evolved. Today, securities regulations permit considerable flexibility in the use of shelf registration statements, as well as in the kind and character of confidential investor discussions that may be conducted with potential investors prior to the public announcement of the launch of a transaction. Unlike in 1984, now private equity and venture capital firms (referred to as financial sponsors below) are key players in the capital markets ecosystem. Today, as a result of the global pandemic, we are watching capital markets volatility that is, essentially, unprecedented in most of our lifetimes. This suggests that issuers across a broad spectrum of industries will be looking to PIPE transactions in order to ensure that they have a future.

While there are now a number of other confidentially marketed securities offering methodologies, for the reasons we discuss below, for many issuers, PIPE transactions may be the most efficient or only alternative. In light of the importance of private equity and venture capital market participants, we are likely to see much more activity in sponsor-led PIPEs. The following discussion is intended to answer some basic questions to which practitioners who may have limited familiarity with PIPE transactions, or more precisely, sponsor-led PIPEs, will want straightforward answers.

What Is a PIPE Transaction?

A PIPE transaction refers to any private placement of equity or equity-linked securities of an already public company. This broad definition encompasses many different types of financings, including everything from a venture-style private placement for a public company to a change of control transaction, to a private placement of highly structured securities. In a typical PIPE transaction, the issuer will engage a placement agent to introduce the issuer principally to institutional accredited investors. These investors will purchase newly issued shares of common stock or securities convertible into, or exchangeable for, shares of common stock at a fixed price in a private placement. Given that the securities are sold in an offering exempt from the registration requirements of Section 5 of the Securities Act of 1933, as amended (the "Securities Act"), the securities will be considered "restricted securities." 2 In order for investors to be able to obtain greater liquidity, as a condition of the transaction, the issuer will covenant to file a registration statement with the Securities and Exchange Commission (the "SEC") that will cover the resale from time to time of the securities purchased by the PIPE investors. The PIPE securities purchase agreement, or sometimes a separate registration rights agreement, will specify certain time periods within which the issuer must file the resale registration statement and in which the issuer must have the registration statement declared effective. Again, to minimize impediments to any resale of the securities by the PIPE investors, the issuer will covenant to limit the number, and the duration, of any suspension (or "blackout") periods during which the resale registration statement will not be available to the PIPE investors. If the resale registration statement were not available, the PIPE investors may nevertheless resell their securities by complying with the Rule 144 sale requirements.

The issuer and investors in a PIPE transaction enter into a securities purchase agreement pursuant to which the investors commit to purchase a specified number of shares at a fixed price. Accordingly, the investor bears the market risk of its investment from the time the transaction is priced (upon entry into the purchase agreement) until closing (when the investor funds its purchase of securities). There are no purchase price adjustments for subsequent events, such as changes in the issuer's stock price. The conditions to closing of the transaction are limited and are outside of the investor's control. As a result, from a securities law perspective, the PIPE transaction is considered "completed" at the time at which the definitive securities purchase agreements are executed.

A PIPE transaction is actually a combination of two separate components. First, the issuer (or one or more selling security holders, if secondary shares are part of the transaction) sells shares of common stock to investors in a private transaction. Second, the issuer files a resale registration statement covering the possible resale from time to time by the investors of the securities purchased in the PIPE transaction. Since the PIPE transaction is a private offering, the issuer and the placement agent must comply with all of the conditions for the applicable exemption from registration. Generally, a PIPE transaction will be structured to comply with the section 4(a)(2) exemption under the Securities Act and the Regulation D safe harbor. Typically, the issuer will rely on Rule 506 of Regulation D.

Why Would a Public Company Consider a PIPE Transaction Instead of Another Capital-Raising Alternative?

In a traditional, fully marketed underwritten public offering, the issuer often discloses the transaction at the launch. For many follow-on public offerings by public issuers, the issuer will file a registration statement (assuming it does not have a shelf registration statement available). The filing of the registration statement alerts the market to a possible offering. In the case of a fully marketed underwritten takedown from the issuer's shelf registration statement, the issuer may file a preliminary prospectus supplement, which has the same effect of alerting the market to an upcoming offering. A public announcement will often have a negative effect on the issuer's stock price. However, an issuer publicly discloses a PIPE transaction only after definitive securities purchase agreements have been executed. Investors are approached by the placement agent on a confidential, or "wall crossed," basis, as discussed below. This allows the issuer to gauge interest in the transaction. If the issuer does not receive sufficient interest or does not like the proposed purchase price discussion, it does not have to proceed with the PIPE transaction. The issuer can elect not to proceed without any negative publicity.

When the PIPE transaction format was developed in the mid-1980s, there were fewer issuers that were eligible to file a shelf registration statement. The confidential and targeted marketing process that is central to a PIPE transaction was, therefore, quite important as a way of minimizing investor front-running. Over time, the SEC has amended the eligibility criteria for use of a primary shelf registration statement, and more issuers, including smaller issuers, may now file a shelf registration statement. While this has expanded the range of offering alternatives available to issuers, PIPE transactions remain an important capital-raising approach. In a number of special situations, a PIPE transaction will be the most efficient, or sometimes the only, financing approach. This is especially true during periods of heightened market volatility and disruption.3

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Footnotes

1 One of the authors, James R. Tanenbaum, developed this financing methodology for Bear, Stearns & Co. Inc. It executed the first PIPE transaction in 1984 for New Jersey National Corporation, a regional bank holding company. Together, the authors have executed over 300 PIPE transactions.

2 See 17 C.F.R. § 230.144(a)(3) definition of "restricted securities."

3 For example, in this article, we discuss a PIPE transaction that involves financial sponsor investors. An issuer also may use a PIPE transaction as a means of raising proceeds to fund an acquisition. To the extent that the acquisition may be material, the issuer may not have available to it an effective shelf registration statement because necessary historical target financial information may be required to be filed in order for the registration statement to be current.

Originally published July 16, 2020.

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