Post by Sapphire Capital on Jul 12, 2008 0:26:31 GMT 4
PIPE - Private Investment in Public Equity
Source: From a legal advisory issued by Testa, Hurwitz & Thibeault, LLP
In a PIPE transaction, investors purchase securities directly from a publicly traded company in a private placement, typically at a discount to the market price of the company's common stock. The sale of the securities is not pre-registered with the SEC, the securities are ‘restricted' and cannot be immediately resold by the investors into the public markets. The company will usually agree as part of the PIPE deal promptly to register the restricted securities with the SEC. The PIPE transaction can offer the company the speed and predictability of a private placement, while providing investors with a nearly liquid security at a discount from the current trading price.
PIPE flavors
PIPE transactions come in many varieties - differing on the basis of the structure and terms of the deal, the securities offered, and the investor base.
‘Pure PIPE' vs ‘Standard PIPE.' In a ‘pure' PIPE, investors agree to purchase the company's securities in a private placement on the condition that a registration statement for the resale of those securities is declared effective by the SEC immediately after the closing of the private placement. The closing of the pure PIPE transaction, therefore, is delayed until the effective date of the registration statement, giving investors the immediate ability to resell the securities purchased in the PIPE. Due in large part to the legal concerns raised by this structure, a number of investment banking firms will not undertake these pure PIPE transactions.
In contrast, a ‘standard' PIPE transaction is structured so that the private placement of the securities is closed not only prior to the effectiveness of the resale registration statement, but also prior to the filing of such registration statement with the SEC. The company agrees in the PIPE documents to file for the registration of such securities promptly following the closing (typically within ten days of the closing) and to use its best efforts to obtain effectiveness of the registration statement (generally within 30 days of the filing). However, depending on whether or not the SEC opts to review the registration statement, the resale registration process can take several months to complete. Due in large part to this period of illiquidity, investors typically purchase their PIPE securities at a discount to the public market price.
Securities issued. Although various types of debt and equity securities, as well as more exotic securities such as derivatives, can be sold and registered with the SEC in a PIPE transaction, most PIPEs involve the issuance by the company of common stock, convertible preferred stock or convertible debt. As an inducement to complete the PIPE financing, investors also may require warrants as a ‘sweetener.' Warrant terms vary widely, but typically include an exercise price set at a premium to the current market price.
Traditional. The majority of ‘traditional' PIPEs involve the sale of common stock at a fixed price that reflects a set discount (generally five per cent to 15 per cent) from the current market price of the company's common stock. However, traditional PIPEs may instead consist of the sale of preferred stock which, at the investor's election, is convertible into common stock at a fixed conversion price. Such preferred stock may entitle the investors to dividends and other rights and, in a sale, merger or liquidation of the company, will provide the investor with the right to receive back the purchase price of the preferred stock prior to any distributions to the holders of common stock. These benefits can be argued to off-set the illiquidity discount applicable to traditional common stock PIPEs, and therefore traditional preferred stock PIPEs are often priced at or near the current market price of the company's common stock.
Structured. In a ‘structured' PIPE, the company will sell preferred stock or debt securities which, in either case, are convertible into the company's common stock. The conversion price in a structured PIPE, however, is either variable or contains a re-set mechanism that automatically adjusts the conversion price downwards (ie, allows the investor to acquire more shares) if the market price of the company's common stock falls below the conversion or re-set price fixed at the time of issuance. Structured PIPEs provide price protection to investors but subject the company's common stockholders to the risk of significant dilution. Additionally, a structured PIPE transaction may require shareholder approval prior to the issuance of the PIPE securities. In 2001, according to industry surveys, approximately 23 per cent of all PIPE transactions (representing only ten per cent of dollars raised) were structured PIPEs.
The ‘Death Spiral' PIPE. If improperly structured, PIPE transactions have the potential for significant shareholder dilution. Such ‘toxic' transactions typically involve a convertible security with a conversion price that is linked, often at a discount, to the market price of the company's common stock at a discount to the current market price, the discount provides a built-in economic gain, which creates the incentive immediately to sell the securities purchased instead of holding them. As the company's stock price drops, the company is required to issue more stock under the terms of the PIPE transaction. These additional issuances cause further downward price pressure, and the price of the common stock often enters a ‘death spiral.'
The effect of toxic financings is hastened by their unpopularity with institutional investors. Institutional investors are wary of the extreme dilutive effect on the holders of common stock and the historically inevitable decline of their own investments as a result of toxic transactions. Merely announcing a PIPE transaction that does not sufficiently limit the ultimate dilution suffered by current stockholders can negatively impact the company's stock price as existing investors attempt to sell their positions before the results are manifested.
Investor base
PIPE deals are marketed and sold to a wide range of investors, largely depending upon the type of PIPE (eg, pure vs standard, traditional vs structured), the size and industry of the company and the quality of the placement agent, if any, involved in the transaction. Historically, PIPEs were not sold to traditional private equity investors, but rather to sophisticated public market investors focused not only on the fundamentals of the company but also on the technical aspects of public market investing dynamics, such as trading volume, float and volatility. These investors generally do not seek board seats or special approval rights and, apart from their right to a resale registration, are content to be treated as ‘outside' investors.
Recently, a growing number of traditional venture capital firms have made investments in PIPE transactions. Although many of these investments have been structured in a fairly straight-forward manner, it is not uncommon for venture capitalists to attempt to transpose to the PIPE arena the full-blown rights and protections that they typically seek with respect to private company preferred stock investments. Often, such ‘venture capital PIPE' investments will raise a host of issues under the federal securities laws, corporate laws and the Nasdaq rules. Venture capital firms should also carefully review their partnership agreements to determine whether or not an investment in a PIPE transaction is permissible.
Doing the deal
A significant advantage of PIPE transactions over traditional public offerings is that they can be completed rapidly - typically two to three weeks from kick-off to closing. In a typical PIPE transaction, due diligence is limited in scope because of the compressed time frame, and generally consists of a review of the company's filings with the SEC and press releases and investigative conference calls with the company's management, counsel and accountants.
The documentation for a PIPE financing is relatively minimal: typically consisting of an offering circular summarising the terms of the financing and containing a description of the business of the company taken directly from the company's filings with the SEC, a purchase agreement, a registration rights agreement, an investor questionnaire, a legal opinion from company counsel and, in the case of a convertible preferred stock offering, a certificate of designations or charter amendment defining the rights and privileges of the preferred stock.
After the closing of the financing transaction, the company and its counsel prepare and file the registration statement to register for resale by the investors the common stock issued (or issuable on conversion of preferred stock or other securities issued) in the PIPE. Typically, the registration statement is filed within ten days after the closing, and the company is required to use its best efforts to have the SEC declare the registration statement effective within thirty days after the filing. The SEC may elect to review and comment on the registration statement, which could delay the effectiveness past this 30-day commitment. Once the SEC is satisfied with the registration statement, it will declare it effective and resales of the PIPE securities may begin. The company must keep the registration statement up to date during the entire time that PIPE investors are reselling their restricted securities pursuant to the registration statement.
The tumultuous public markets of the past two years have resulted in increased interest by private investors in PIPE (private investment in public equity) transactions. PIPE investors purchase securities directly from a publicly traded company in a private placement transaction, typically at a discount to the market price of the company's common stock. Because the sale of the securities is not pre-registered with the SEC, the securities are “restricted” and cannot be immediately resold by the investors into the public markets. Accordingly, the company will agree as part of the PIPE deal promptly to register the restricted securities with the SEC. Thus, the PIPE transaction can offer the company the speed and predictability of a private placement, while providing investors with a nearly-liquid security at a discount from the current trading price.
Careful attention must be given to multiple legal issues that arise during the course of PIPE transactions. The compressed time frame of these financings leaves little margin for error or uncertainty. This article examines some of the key legal issues arising out of these transactions.
Valid Private Placement
The initial sale of securities by the company in a PIPE transaction must be completed as a valid private placement under federal and state securities laws. PIPEs are typically structured to comply with the exemption from registration contained in Section 4(2) of the Securities Act and/or the SEC's Regulation D safe harbor. The availability of these exemptions will depend upon the sophistication and financial status of the offerees and purchasers, the extent to which the offerees and purchasers have access to information about the company, the number of persons to whom offers are made, the number of purchasers (though neither the number of offerees nor purchasers is determinative) and the purchasers' intention about maintaining their investment in the company. Investors in a PIPE transaction typically will be required to represent to the company that they are “accredited investors” as defined in Regulation D. In addition, the offering must be conducted so as to avoid general solicitation or advertisement. Accordingly, the manner in which the company and any placement agent identify potential investors must also be considered.
Integration With a Public Offering
The SEC's “integration doctrine” is designed to prevent companies from improperly avoiding registration by dividing what may be considered, in substance, a single securities offering into multiple offerings. The SEC will examine multiple securities offerings of a company to see whether they should be treated as a single offering for the purpose of determining if the registration requirements of the Securities Act have been met, or if a valid exemption from registration exists. If a private and public offering are integrated, the general solicitation undertaken in the public offering, even if abandoned, may destroy the exemption for the private placement, resulting in a violation of the securities laws.
Accordingly, in order to avoid a “burst PIPE”, the company's past and proposed financing efforts should be reviewed to ensure that the private placement in the PIPE will not be “integrated” with:
• any public offerings completed or abandoned prior to the PIPE financing,
• the proposed subsequent registered resale of the securities issued in the PIPE, or
• any concurrent registered offering (including an active shelf registration statement).
Abandoned Public Offerings. Special integration considerations arise for companies commencing a PIPE transaction shortly after abandoning a public offering. The SEC's Rule 155 provides an integration safe harbor that enables a company to withdraw its public offering registration statement and commence private financing activities 30 days later. By contrast, before Rule 155, companies often were required to wait six months after withdrawal before commencing a private financing.
Subsequent Registration. The SEC has determined that a private placement of securities will not be integrated with the subsequent registered resale of those securities if the private placement was “completed” prior to the filing of the registration statement. The SEC will consider a private placement completed in either of two situations:
• all of the purchasers have fully paid the purchase price for the securities in the private offering, or
• each purchaser is irrevocably obligated to purchase a set number of securities, the purchase price is fixed (i.e., not contingent on market price or a fluctuating ratio) and the transaction cannot be renegotiated.
So-called “pure” PIPE transactions are designed to comply with the second of these tests, but the complexity of legal issues involved with that standard has made this an unattractive alternative for many companies and most major investment banks.
Concurrent Public and Private Offerings. As a policy matter, the SEC has permitted concurrent registered and private offerings to be made under the conditions set forth in its Black Box and other related “no action” letters. A “Black Box PIPE” would be undertaken, for example, during a period when the company has on file an effective resale or shelf registration statement. In such situations, the SEC requires that the private offering be made only to:
• persons who are qualified institutional buyers (QIBs) as defined in Rule 144A(a) under the Securities Act, and/or
• no more than two or three large institutional accredited investors.
In addition, the PIPE must otherwise qualify as a valid private placement.
Shareholder Approval
Nasdaq's shareholder approval rules may apply to a PIPE financing and can provide a trap for the unwary — particularly with respect to “venture capital PIPES.” For example, Nasdaq–listed public companies are required to obtain shareholder approval prior to the issuance of PIPE securities if the amount of common stock issued (or ultimately issuable due to any conversion or re-set mechanism) exceeds 20% of the company's outstanding common stock, unless the stock is issued at a price that equals or exceeds both the book and market value of the stock (which often is not the case in a PIPE transaction).
Further, if officers or directors are purchasing shares in a transaction that is priced below fair market value, Nasdaq requires prior shareholder approval unless their portion of the offering does not exceed the lesser of 1% of the company's outstanding stock or 25,000 shares (in the aggregate for all participating officers and directors). If an affiliate (such as a private equity firm) of an officer or director is investing in the PIPE, the company must examine whether the officer or director has a direct or indirect interest in the shares. Nasdaq has informally indicated that if the shares held by the affiliated firm are attributed to the director or officer in the company's proxy statement (as is often the case with a director affiliated with a private equity fund stockholder), then that director or officer is deemed to have an interest in and a benefit from the affiliate's investment in the PIPE even if he or she disclaims beneficial ownership of the affiliate's shares.
Nasdaq, however, provides a limited exception to the shareholder approval requirement if the company can establish to Nasdaq's satisfaction that the delay associated with obtaining shareholder approval would seriously jeopardize the company's financial viability. The use of this exception must be specifically approved by the company's board of directors or audit committee and disclosed in a press release and notice to the company's stockholders at least ten days prior to any issuance of securities.
Regulation FD
The SEC's Regulation FD prohibits the selective disclosure of material non-public information by public companies. Under Regulation FD, a publicly traded company that intentionally discloses material non-public information must do so in a manner designed to effect broad public dissemination of the information. Inadvertent selective disclosures must be cured promptly by disclosing the information publicly. Although Regulation FD excludes communications made in connection with most registered securities offerings, statements made in connection with private placements — including PIPE transactions — are not excluded. Companies engaging in PIPE financings need either to obtain nondisclosure agreements from, or refrain from providing any material, non-public information to, prospective investors. As a practical matter, obtaining free-standing nondisclosure agreements from potential investors in a PIPE transaction is often difficult, and many placement agents do not even attempt to do so. A common practice is to obtain oral nondisclosure commitments from the potential investors, and to bolster that with a “shrink-wrap” nondisclosure statement on the company's PIPE offering materials and a confidentiality representation and covenant from the actual investors in the final purchase document.
Regulation M
The SEC's Regulation M governs the extent to which placement agents may purchase or induce others to purchase securities of a company while a “distribution” is taking place. Unless the company's common stock is “actively traded” as defined in Regulation M, the placement agent will be required to stay out of the public market during the PIPE transaction (one or five business days prior to pricing, depending upon the dollar amount of the company's trading volume and public float).
Research Reports
The federal securities laws place restrictions on the ability of the placement agent's analysts to issue research reports with respect to the company from the time the placement agent is invited to participate in the company's PIPE financing until firm orders for all available shares of the restricted PIPE securities have been received. It should be noted that these restrictions are less stringent for large capitalization companies.
Conclusion
While the public offering markets have slowed over the last two years, the need to raise capital has not. More and more companies are utilizing alternative financing techniques, such as PIPEs, in lieu of traditional public offerings to secure financing whenever an opportunity presents itself. Although PIPE transactions may once have been uncommon or viewed unfavorably in the marketplace, properly structured PIPE transactions sold to well-chosen, established investors are now widely accepted as rapid and legitimate financing vehicles for companies seeking to raise funds to support growth.
The added links have not been from the same source but have been attached in-house for further reading:
Links:
a. Structuring PIPE Transactions In Europe: www.kirkland.com/siteFiles/kirkexp/publications/2478/Document1/PIPEs.pdf
b. Overview: www.friedlandcapital.com/PDFs/White%20Paper%20-%20PIPEs.pdf
c. Overview: www.friedlandcapital.com/PDFs/White%20Paper%20-%20PIPEs.pdf
d. FAQ: www.realcorporatelawyer.com/faqs/faqpipes.html
e. SEC and Hedge Fund Problems with PIPE’s : www.willkie.com/files/tbl_s29Publications%5CFileUpload5686%5C2261%5CRegulators_Continue_to_Focus_on_PIPE_Transactions.pdf
f. In India: www.abanet.org/buslaw/committees/CL930000pub/newsletter/200703/singh.pdf
g. Venture Capital? : www.yvcs.org/uploads/1134936958Pipes%20Article%20December%202005_revised%20Final_2.pdf
h. Diversification: www.diversifiedfinancialservices.net/files/Pipe_replacement.pdf
i. Source: www.altassets.com/knowledgebank/learningcurve/2002/nz2856.php
And www.altassets.com/casefor/countries/2003/nz3597.php
Source: From a legal advisory issued by Testa, Hurwitz & Thibeault, LLP
In a PIPE transaction, investors purchase securities directly from a publicly traded company in a private placement, typically at a discount to the market price of the company's common stock. The sale of the securities is not pre-registered with the SEC, the securities are ‘restricted' and cannot be immediately resold by the investors into the public markets. The company will usually agree as part of the PIPE deal promptly to register the restricted securities with the SEC. The PIPE transaction can offer the company the speed and predictability of a private placement, while providing investors with a nearly liquid security at a discount from the current trading price.
PIPE flavors
PIPE transactions come in many varieties - differing on the basis of the structure and terms of the deal, the securities offered, and the investor base.
‘Pure PIPE' vs ‘Standard PIPE.' In a ‘pure' PIPE, investors agree to purchase the company's securities in a private placement on the condition that a registration statement for the resale of those securities is declared effective by the SEC immediately after the closing of the private placement. The closing of the pure PIPE transaction, therefore, is delayed until the effective date of the registration statement, giving investors the immediate ability to resell the securities purchased in the PIPE. Due in large part to the legal concerns raised by this structure, a number of investment banking firms will not undertake these pure PIPE transactions.
In contrast, a ‘standard' PIPE transaction is structured so that the private placement of the securities is closed not only prior to the effectiveness of the resale registration statement, but also prior to the filing of such registration statement with the SEC. The company agrees in the PIPE documents to file for the registration of such securities promptly following the closing (typically within ten days of the closing) and to use its best efforts to obtain effectiveness of the registration statement (generally within 30 days of the filing). However, depending on whether or not the SEC opts to review the registration statement, the resale registration process can take several months to complete. Due in large part to this period of illiquidity, investors typically purchase their PIPE securities at a discount to the public market price.
Securities issued. Although various types of debt and equity securities, as well as more exotic securities such as derivatives, can be sold and registered with the SEC in a PIPE transaction, most PIPEs involve the issuance by the company of common stock, convertible preferred stock or convertible debt. As an inducement to complete the PIPE financing, investors also may require warrants as a ‘sweetener.' Warrant terms vary widely, but typically include an exercise price set at a premium to the current market price.
Traditional. The majority of ‘traditional' PIPEs involve the sale of common stock at a fixed price that reflects a set discount (generally five per cent to 15 per cent) from the current market price of the company's common stock. However, traditional PIPEs may instead consist of the sale of preferred stock which, at the investor's election, is convertible into common stock at a fixed conversion price. Such preferred stock may entitle the investors to dividends and other rights and, in a sale, merger or liquidation of the company, will provide the investor with the right to receive back the purchase price of the preferred stock prior to any distributions to the holders of common stock. These benefits can be argued to off-set the illiquidity discount applicable to traditional common stock PIPEs, and therefore traditional preferred stock PIPEs are often priced at or near the current market price of the company's common stock.
Structured. In a ‘structured' PIPE, the company will sell preferred stock or debt securities which, in either case, are convertible into the company's common stock. The conversion price in a structured PIPE, however, is either variable or contains a re-set mechanism that automatically adjusts the conversion price downwards (ie, allows the investor to acquire more shares) if the market price of the company's common stock falls below the conversion or re-set price fixed at the time of issuance. Structured PIPEs provide price protection to investors but subject the company's common stockholders to the risk of significant dilution. Additionally, a structured PIPE transaction may require shareholder approval prior to the issuance of the PIPE securities. In 2001, according to industry surveys, approximately 23 per cent of all PIPE transactions (representing only ten per cent of dollars raised) were structured PIPEs.
The ‘Death Spiral' PIPE. If improperly structured, PIPE transactions have the potential for significant shareholder dilution. Such ‘toxic' transactions typically involve a convertible security with a conversion price that is linked, often at a discount, to the market price of the company's common stock at a discount to the current market price, the discount provides a built-in economic gain, which creates the incentive immediately to sell the securities purchased instead of holding them. As the company's stock price drops, the company is required to issue more stock under the terms of the PIPE transaction. These additional issuances cause further downward price pressure, and the price of the common stock often enters a ‘death spiral.'
The effect of toxic financings is hastened by their unpopularity with institutional investors. Institutional investors are wary of the extreme dilutive effect on the holders of common stock and the historically inevitable decline of their own investments as a result of toxic transactions. Merely announcing a PIPE transaction that does not sufficiently limit the ultimate dilution suffered by current stockholders can negatively impact the company's stock price as existing investors attempt to sell their positions before the results are manifested.
Investor base
PIPE deals are marketed and sold to a wide range of investors, largely depending upon the type of PIPE (eg, pure vs standard, traditional vs structured), the size and industry of the company and the quality of the placement agent, if any, involved in the transaction. Historically, PIPEs were not sold to traditional private equity investors, but rather to sophisticated public market investors focused not only on the fundamentals of the company but also on the technical aspects of public market investing dynamics, such as trading volume, float and volatility. These investors generally do not seek board seats or special approval rights and, apart from their right to a resale registration, are content to be treated as ‘outside' investors.
Recently, a growing number of traditional venture capital firms have made investments in PIPE transactions. Although many of these investments have been structured in a fairly straight-forward manner, it is not uncommon for venture capitalists to attempt to transpose to the PIPE arena the full-blown rights and protections that they typically seek with respect to private company preferred stock investments. Often, such ‘venture capital PIPE' investments will raise a host of issues under the federal securities laws, corporate laws and the Nasdaq rules. Venture capital firms should also carefully review their partnership agreements to determine whether or not an investment in a PIPE transaction is permissible.
Doing the deal
A significant advantage of PIPE transactions over traditional public offerings is that they can be completed rapidly - typically two to three weeks from kick-off to closing. In a typical PIPE transaction, due diligence is limited in scope because of the compressed time frame, and generally consists of a review of the company's filings with the SEC and press releases and investigative conference calls with the company's management, counsel and accountants.
The documentation for a PIPE financing is relatively minimal: typically consisting of an offering circular summarising the terms of the financing and containing a description of the business of the company taken directly from the company's filings with the SEC, a purchase agreement, a registration rights agreement, an investor questionnaire, a legal opinion from company counsel and, in the case of a convertible preferred stock offering, a certificate of designations or charter amendment defining the rights and privileges of the preferred stock.
After the closing of the financing transaction, the company and its counsel prepare and file the registration statement to register for resale by the investors the common stock issued (or issuable on conversion of preferred stock or other securities issued) in the PIPE. Typically, the registration statement is filed within ten days after the closing, and the company is required to use its best efforts to have the SEC declare the registration statement effective within thirty days after the filing. The SEC may elect to review and comment on the registration statement, which could delay the effectiveness past this 30-day commitment. Once the SEC is satisfied with the registration statement, it will declare it effective and resales of the PIPE securities may begin. The company must keep the registration statement up to date during the entire time that PIPE investors are reselling their restricted securities pursuant to the registration statement.
The tumultuous public markets of the past two years have resulted in increased interest by private investors in PIPE (private investment in public equity) transactions. PIPE investors purchase securities directly from a publicly traded company in a private placement transaction, typically at a discount to the market price of the company's common stock. Because the sale of the securities is not pre-registered with the SEC, the securities are “restricted” and cannot be immediately resold by the investors into the public markets. Accordingly, the company will agree as part of the PIPE deal promptly to register the restricted securities with the SEC. Thus, the PIPE transaction can offer the company the speed and predictability of a private placement, while providing investors with a nearly-liquid security at a discount from the current trading price.
Careful attention must be given to multiple legal issues that arise during the course of PIPE transactions. The compressed time frame of these financings leaves little margin for error or uncertainty. This article examines some of the key legal issues arising out of these transactions.
Valid Private Placement
The initial sale of securities by the company in a PIPE transaction must be completed as a valid private placement under federal and state securities laws. PIPEs are typically structured to comply with the exemption from registration contained in Section 4(2) of the Securities Act and/or the SEC's Regulation D safe harbor. The availability of these exemptions will depend upon the sophistication and financial status of the offerees and purchasers, the extent to which the offerees and purchasers have access to information about the company, the number of persons to whom offers are made, the number of purchasers (though neither the number of offerees nor purchasers is determinative) and the purchasers' intention about maintaining their investment in the company. Investors in a PIPE transaction typically will be required to represent to the company that they are “accredited investors” as defined in Regulation D. In addition, the offering must be conducted so as to avoid general solicitation or advertisement. Accordingly, the manner in which the company and any placement agent identify potential investors must also be considered.
Integration With a Public Offering
The SEC's “integration doctrine” is designed to prevent companies from improperly avoiding registration by dividing what may be considered, in substance, a single securities offering into multiple offerings. The SEC will examine multiple securities offerings of a company to see whether they should be treated as a single offering for the purpose of determining if the registration requirements of the Securities Act have been met, or if a valid exemption from registration exists. If a private and public offering are integrated, the general solicitation undertaken in the public offering, even if abandoned, may destroy the exemption for the private placement, resulting in a violation of the securities laws.
Accordingly, in order to avoid a “burst PIPE”, the company's past and proposed financing efforts should be reviewed to ensure that the private placement in the PIPE will not be “integrated” with:
• any public offerings completed or abandoned prior to the PIPE financing,
• the proposed subsequent registered resale of the securities issued in the PIPE, or
• any concurrent registered offering (including an active shelf registration statement).
Abandoned Public Offerings. Special integration considerations arise for companies commencing a PIPE transaction shortly after abandoning a public offering. The SEC's Rule 155 provides an integration safe harbor that enables a company to withdraw its public offering registration statement and commence private financing activities 30 days later. By contrast, before Rule 155, companies often were required to wait six months after withdrawal before commencing a private financing.
Subsequent Registration. The SEC has determined that a private placement of securities will not be integrated with the subsequent registered resale of those securities if the private placement was “completed” prior to the filing of the registration statement. The SEC will consider a private placement completed in either of two situations:
• all of the purchasers have fully paid the purchase price for the securities in the private offering, or
• each purchaser is irrevocably obligated to purchase a set number of securities, the purchase price is fixed (i.e., not contingent on market price or a fluctuating ratio) and the transaction cannot be renegotiated.
So-called “pure” PIPE transactions are designed to comply with the second of these tests, but the complexity of legal issues involved with that standard has made this an unattractive alternative for many companies and most major investment banks.
Concurrent Public and Private Offerings. As a policy matter, the SEC has permitted concurrent registered and private offerings to be made under the conditions set forth in its Black Box and other related “no action” letters. A “Black Box PIPE” would be undertaken, for example, during a period when the company has on file an effective resale or shelf registration statement. In such situations, the SEC requires that the private offering be made only to:
• persons who are qualified institutional buyers (QIBs) as defined in Rule 144A(a) under the Securities Act, and/or
• no more than two or three large institutional accredited investors.
In addition, the PIPE must otherwise qualify as a valid private placement.
Shareholder Approval
Nasdaq's shareholder approval rules may apply to a PIPE financing and can provide a trap for the unwary — particularly with respect to “venture capital PIPES.” For example, Nasdaq–listed public companies are required to obtain shareholder approval prior to the issuance of PIPE securities if the amount of common stock issued (or ultimately issuable due to any conversion or re-set mechanism) exceeds 20% of the company's outstanding common stock, unless the stock is issued at a price that equals or exceeds both the book and market value of the stock (which often is not the case in a PIPE transaction).
Further, if officers or directors are purchasing shares in a transaction that is priced below fair market value, Nasdaq requires prior shareholder approval unless their portion of the offering does not exceed the lesser of 1% of the company's outstanding stock or 25,000 shares (in the aggregate for all participating officers and directors). If an affiliate (such as a private equity firm) of an officer or director is investing in the PIPE, the company must examine whether the officer or director has a direct or indirect interest in the shares. Nasdaq has informally indicated that if the shares held by the affiliated firm are attributed to the director or officer in the company's proxy statement (as is often the case with a director affiliated with a private equity fund stockholder), then that director or officer is deemed to have an interest in and a benefit from the affiliate's investment in the PIPE even if he or she disclaims beneficial ownership of the affiliate's shares.
Nasdaq, however, provides a limited exception to the shareholder approval requirement if the company can establish to Nasdaq's satisfaction that the delay associated with obtaining shareholder approval would seriously jeopardize the company's financial viability. The use of this exception must be specifically approved by the company's board of directors or audit committee and disclosed in a press release and notice to the company's stockholders at least ten days prior to any issuance of securities.
Regulation FD
The SEC's Regulation FD prohibits the selective disclosure of material non-public information by public companies. Under Regulation FD, a publicly traded company that intentionally discloses material non-public information must do so in a manner designed to effect broad public dissemination of the information. Inadvertent selective disclosures must be cured promptly by disclosing the information publicly. Although Regulation FD excludes communications made in connection with most registered securities offerings, statements made in connection with private placements — including PIPE transactions — are not excluded. Companies engaging in PIPE financings need either to obtain nondisclosure agreements from, or refrain from providing any material, non-public information to, prospective investors. As a practical matter, obtaining free-standing nondisclosure agreements from potential investors in a PIPE transaction is often difficult, and many placement agents do not even attempt to do so. A common practice is to obtain oral nondisclosure commitments from the potential investors, and to bolster that with a “shrink-wrap” nondisclosure statement on the company's PIPE offering materials and a confidentiality representation and covenant from the actual investors in the final purchase document.
Regulation M
The SEC's Regulation M governs the extent to which placement agents may purchase or induce others to purchase securities of a company while a “distribution” is taking place. Unless the company's common stock is “actively traded” as defined in Regulation M, the placement agent will be required to stay out of the public market during the PIPE transaction (one or five business days prior to pricing, depending upon the dollar amount of the company's trading volume and public float).
Research Reports
The federal securities laws place restrictions on the ability of the placement agent's analysts to issue research reports with respect to the company from the time the placement agent is invited to participate in the company's PIPE financing until firm orders for all available shares of the restricted PIPE securities have been received. It should be noted that these restrictions are less stringent for large capitalization companies.
Conclusion
While the public offering markets have slowed over the last two years, the need to raise capital has not. More and more companies are utilizing alternative financing techniques, such as PIPEs, in lieu of traditional public offerings to secure financing whenever an opportunity presents itself. Although PIPE transactions may once have been uncommon or viewed unfavorably in the marketplace, properly structured PIPE transactions sold to well-chosen, established investors are now widely accepted as rapid and legitimate financing vehicles for companies seeking to raise funds to support growth.
The added links have not been from the same source but have been attached in-house for further reading:
Links:
a. Structuring PIPE Transactions In Europe: www.kirkland.com/siteFiles/kirkexp/publications/2478/Document1/PIPEs.pdf
b. Overview: www.friedlandcapital.com/PDFs/White%20Paper%20-%20PIPEs.pdf
c. Overview: www.friedlandcapital.com/PDFs/White%20Paper%20-%20PIPEs.pdf
d. FAQ: www.realcorporatelawyer.com/faqs/faqpipes.html
e. SEC and Hedge Fund Problems with PIPE’s : www.willkie.com/files/tbl_s29Publications%5CFileUpload5686%5C2261%5CRegulators_Continue_to_Focus_on_PIPE_Transactions.pdf
f. In India: www.abanet.org/buslaw/committees/CL930000pub/newsletter/200703/singh.pdf
g. Venture Capital? : www.yvcs.org/uploads/1134936958Pipes%20Article%20December%202005_revised%20Final_2.pdf
h. Diversification: www.diversifiedfinancialservices.net/files/Pipe_replacement.pdf
i. Source: www.altassets.com/knowledgebank/learningcurve/2002/nz2856.php
And www.altassets.com/casefor/countries/2003/nz3597.php