PIPES: Another Approach to Raising Public Money
Ted Roth, Managing Director, Investment Banking, Roth Capital Partners
Private Investment in Public Equity (PIPE) as a vehicle for companies to raise capital reverses the order of public filings from that in an initial public offering (IPO) or a follow-on (secondary) offering. That is, in a PIPE, the company files a registration statement with the Securities and Exchange Commission (SEC) after—rather than before—the shares to be registered are sold. As a result, investors, as opposed to the entrepreneur, assume most of the liquidity risk.
Reversing the Process
In a traditional underwritten offering, the company (regardless of whether it is currently public or privately owned) files a registration statement with the SEC, telling the public that it intends to sell a certain number of shares. Following SEC review and approval of the registration statement, the company and its investment bankers go on a road show, meeting with prospective investors to determine their interest in purchasing shares in the offering. Once the investment bankers determine the investor demand for shares and pricing, it makes a proposal to the company. If the company agrees, the stock is purchased from the company by the investment bankers, who in turn sell it to the investors, who have the ability to re-sell the shares immediately because it has already gone through the registration process and is fully tradeable.
In a PIPE transaction for a public company, the steps are reversed. The company and its investment bankers commence a non-public, confidential road show, meeting with potential investors who have previously agreed that they will not trade in the company's stock or disclose that the company is contemplating the sale of shares. Once the company (with help from its investment bankers) and the prospective investors agree upon the number of shares to be sold and the pricing, the stock is purchased by the investors directly from the company. As part of the transaction, the company agrees that it will file a registration statement for the resale of the shares within a certain period of time (typically sixty days). Until that registration statement has been declared effective by the SEC, the investors assume the liquidity risk. Accordingly, the shares are frequently sold at a discount (10-20 percent) to the current market price.
Until recently, PIPEs were almost exclusively used by companies that were already public. Increasingly, private company entrepreneurs are electing to go public through methods that do not involve the traditional IPO process. These methods include a direct public offering by the company or the merger into a company that is already public but has little, if any, current business operations (i.e, a public shell). The PIPE transaction in this instance is accomplished similar to that of a public company, frequently with the condition that the PIPE will not close until the completion of the merger with the public shell if that is the method utilized for going public. A reverse merger does add a bit of complexity to the process, as the private company must initially find a suitable public shell (usually with help from a law firm or investment banker), and negotiate the price and amount of ownership to be retained by the shell owners after the merger is completed (generally less than 5 percent)
Pros & Cons
Irrespective of the method that a private company employs to go public, it is important that the owners and management of the company have considered all of the aspects of being a public company. In addition to the corporate governance requirements of regulations like Sarbanes-Oxley, the necessary disclosure of business information could compromise the company's position in a competitive industry, financial reporting on a quarterly basis can lead to confusion in a seasonal industry, and the need to continually update the investing public can affect management's ability to operate the business. Raising public money through a PIPE should only be attempted by companies that are ready to be public.
In comparing the two methods, a PIPE can generally be closed more quickly than an IPO, which takes six-to-nine months. If the entrepreneur needs money faster than that or is concerned that market conditions for selling stock may be less favorable at a later time, a PIPE may be a logical choice. Since in a PIPE the money is raised prior to filing the registration statement, a large portion of the cost of filing can be deferred until after the money has been raised.
Nevertheless, there are some disadvantages to a PIPE, which is very quiet, compared to an IPO, which is very public. In an IPO, with several investment banks, the shares are likely to achieve a much broader distribution and greater exposure to the investment community after the transaction. Whereas upwards of one hundred investors may participate in an IPO, there may be ten or twenty in a PIPE. Even if investors don't participate in the IPO, they know about the company and may buy shares later on the open market. In a PIPE, the company meets with fewer investors on the road show and will need to generate future investor interest on its own.
The other important disadvantage of a reverse merger method for going public is the possibility of undisclosed liabilities from the public shell surfacing at a later date.
The PIPES structure clearly has its place among the alternatives for raising public money. While a PIPE should be used selectively and is not a substitute for companies that shouldn't be public in the first place, it is a method to raise capital more efficiently.
© 2006 Ewing Marion Kauffman Foundation. All rights reserved.