• the sale of convertible preferred stock or convert- General Questions about PIPEs ible debt; and
What are PIPEs? • a venture-style private placement for an already- A (Private Investment in Public Equity) refers to public company. any private placement of securities of an already-pub- lic company that is made to selected accredited What are some of the advantage of a PIPE transaction? investors (usually to selected institutional accredited A transaction offers several significant advantages investors) wherein investors enter into a purchase for an issuer, including: agreement committing them to purchase securities • lowering transaction expenses; and, usually,requiring the issuer to file a resale registra- • expanding institutional and accredited investor tion statement covering the resale from time to time of holdings; the securities the investors purchased in the private placement. Equity lines of credit, as described below, • for fixed price transactions, reducing the incentive are not transactions. for investors to hedge their commitment by short- ing the issuer’s stock;
What kinds of securities are sold in PIPE transactions? • requiring disclosure of the transaction to the pub- transactions may involve the sale of common lic only after definitive purchase commitments are stock, convertible preferred stock, convertible deben- received from investors; tures, warrants, or other equity or equity-like securities • requiring preparation by the investor only of very of an already-public company. streamlined information, including publicly filed Exchange Act reports; and What are some of the common varieties of PIPE transactions? • enabling a transaction to close and fund within There are a number of common transactions, seven to ten days of receiving definitive purchase including: commitments. • the sale of common stock at a fixed price;
• the sale of common stock at a fixed price, togeth- Traditional PIPE Transactions er with fixed price warrants; • the sale of common stock at a fixed price, togeth- What is a traditional PIPE transaction? er with resettable or variable priced warrants; A traditional transaction is a private placement • the sale of common stock at a variable price; of either newly issued shares of common stock or shares of common stock held by selling stockholders Non-traditional transactions generally are (or a combination of primary and secondary shares) of structured as private placements with follow-on (or an already-public company that is made through a trailing) registration rights. This means that once placement agent to accredited investors. investors enter into a definitive purchase agreement, a Investors in a traditional transaction commit to closing is scheduled. Investors fund and the transaction purchase a specified number of shares at a fixed price, closes. Post-closing, the company has an obligation to with the closing conditioned upon, among other things, file a resale registration statement and use its best efforts the ’s preparedness to declare effective a resale reg- to have it declared effective. Typically, the purchase istration statement covering the resale from time to time agreement or a separate registration rights agreement of the shares sold in the private placement. outlines specific deadlines for the company to file, and then to seek effectiveness of, the resale registration What is a “black-out” period? statement. Some transactions provide for the In connection with a transaction, an issuer typ- company to make penalty payments if the company ically must keep effective a resale registration state- fails to meet the deadlines set for filing or effectiveness ment for two years. During this two-year period, the of the resale registration statement. In the case of a issuer may suspend the use of a registration statement PIPE structured as a private placement with follow-on because the registration statement must be amended registration rights, the investor will not have the bene- or corrected to remedy a material misstatement or fit of a registration statement for some time, usually 60 omission. This suspension period often is referred to to 90 days following the closing. As a result, investors as a black-out period. During the black-out period, will hold restricted securities for some period of time. the purchasers will have limited liquidity,as they will not be able to avail themselves of the resale regis- What are the standard terms of a traditional PIPE? tration statement to resell the securities purchased in • private placement to selected accredited investors; the transaction. • investors irrevocably commit to purchase a fixed How do traditional PIPE transactions differ from non-tradi- number of securities at a fixed price, not subject to tional PIPE transactions? market price adjustments or to fluctuating ratios; In a traditional transaction, the investor bears the • purchase agreements generally contain a limitation price risk from the time of pricing until the time of on black-out periods; closing. The issuer is not obligated to deliver addition- • immediately following execution of purchase al securities to the investors in the event of fluc- agreements with investors, the issuer files a resale tuations in stock price or otherwise. Investors enter registration statement covering resales from time into a definitive purchase agreement with the compa- to time of the restricted securities sold in the ny in which they commit to purchase securities at a transaction; fixed purchase price. Investors do not fund at the time • closing of the transaction occurs promptly of entering into the purchase agreement. Instead, the upon notice of ’s willingness to declare effec- company then files a resale registration statement cov- tive the resale registration statement; ering the resale from time to time of those securities by the investors. The transaction closes once the • purchasers are named as “Selling Stockholders” in has indicated its preparedness to declare effective the resale registration statement; and the resale registration statement. Consequently,the tra- • resale registration statement kept effective until ditional investors have available a resale registra- shares may be sold under Rule (k). tion statement at the time of closing. Does the placement agent or a lead investor control the process registration statement is declared effective on the day of in a traditional PIPE transaction? closing (but subsequent to the closing) or on the fol- In a traditional transaction, the process is con- lowing business day. trolled by the placement agent, rather than by a lead Once the resale registration statement is declared investor. The placement agent conducts its own busi- effective, purchasers may deliver to the issuer’s transfer ness and financial due diligence. Investors generally agent a certificate (in contemplation of transferring or limit their diligence investigation to discussions with otherwise disposing of the shares) acknowledging that management and the company’s independent auditors. the purchasers recognize their prospectus delivery Traditional purchasers generally do not negotiate requirement in connection with the shares and mak- for themselves ongoing negative covenants or covenants ing certain representations concerning future sales of relating to information rights or corporate governance. the shares. The issuer’s transfer agent then will provide the pur- When does the PIPE purchaser in a traditional PIPE pay chasers with clean (unlegended) securities. This can for the securities? happen at the closing if investors deliver their certifi- No money is exchanged when the purchase agreement cates to the transfer agent. is executed. Purchasers pay the purchase price only when the purchasers are informed that the resale regis- What are the benefits of traditional PIPE transactions com- tration statement is ready to be declared effective. pared to non-traditional PIPE transactions? By comparison to a structured as a private What are the other closing conditions for a traditional PIPE placement with follow-on registration rights, a tradi- transaction? tional reduces uncertainty, market risk, and illiquidity. Purchasers in a traditional are not • purchase agreement contains standard representa- tions and warranties (similar to those contained in required to close until a resale registration statement is available for subsequent sales of the shares pur- an underwriting agreement) that must be brought down at closing; chased in the transaction. Traditional purchasers are able to obtain unlegended shares short- • delivery of a comfort letter and legal opinions ly after, or at, closing, allowing purchasers flexibility in (including a b- negative assurance relating to disposing of the shares. the Private Placement Memorandum and to the For most registered investment funds, securities pur- resale registration statement) to placement agent; chased in a traditional are counted in the funds’ • before an investor obtains unlegended stock certifi- public basket. This broadens the scope of potential cates, delivery by the investor to the issuer and the investors for traditional s and also generally justi- issuer’s transfer agent of a certificate as to the fies better pricing. investor’s compliance with the prospectus delivery requirement; and Non-traditional PIPE Transactions • closing conditions limited to (1) no occurrence of any material adverse change between execution What are the standard terms of non-traditional (or structured) and closing, and (2) the ’s willingness to PIPE transactions? declare effective the resale registration statement. • private placement to selected accredited investors;
At closing, do purchasers in a traditional PIPE transaction • investors commit to purchase securities at a fixed receive restricted securities bearing a legend? price or at a variable/reset price; At the closing of a traditional transaction, pur- • for transactions involving variable/reset pricing, chasers receive legended securities. Typically, the resale the purchase agreement generally contains specific pricing parameters – which may include a cap on • the purchase agreement may, depending on the the maximum number of shares that may be issued nature of the investors, contain ongoing covenants to the purchasers; relating to corporate governance (board represen- tation or observer rights; blocking rights; etc.) or • the purchase agreements generally contain a limi- tation on black-out periods; information requirements (regular deliveries of public filings or other information to investors); • promptly following execution of purchase agree- ments with investors, the transaction closes and • delivery of a comfort letter and legal opinions to funds; the placement agent; • before an investor obtains unlegended stock certifi- • the issuer files a resale registration statement cover- ing resales from time to time of restricted securities cates, delivery by the investor to the issuer and the sold in the transaction; issuer’s transfer agent of a certificate as to the investor’s compliance with the prospectus delivery • the issuer may be obligated to make penalty pay- requirement; and ments if it fails to file the registration statement within the allotted period, or if it fails to use its best • closing conditions are limited to no occurrence of efforts to have the registration statement declared any material adverse change between execution effective within the allotted period; and closing.
• purchasers are named in the resale registration Do purchasers receive restricted (legended) securities at closing? statement as “Selling Stockholders”; and At the closing of a non-traditional transaction, • the resale registration statement is kept effective purchasers receive legended securities. Typically, the until shares may be sold under Rule (k). purchasers will hold these restricted securities for a period of to days (or longer) following the clos- When does the purchaser pay for the securities in a non-tra- ing. During this period, the issuer will file the resale ditional PIPE transaction? registration statement with the and seek to have In a non-traditional transaction, the purchaser it declared effective. If the issuer fails to meet any of pays for the securities at the closing. The closing the deadlines for filing or effectiveness outlined in the generally is scheduled for a date promptly following purchase agreement, the issuer may be required to the execution of all of the purchase agreements. make penalty payments to the purchasers. Purchasers pay for and receive restricted securities Purchasers have limited liquidity during the penden- bearing a Securities Act legend. At closing, pur- cy of the resale registration statement. Once the resale chasers will not have the benefit of an effective resale registration statement is declared effective, the pur- registration statement. chasers will be able to sell their securities pursuant to the resale registration statement, although they will be What are other closing conditions and covenants in non-tradi- required to deliver their legended stock certificates and tional PIPE transactions? a legal opinion to the transfer agent in advance of any
• the purchase agreement contains standard repre- trade. This often results in significant delays. sentations and warranties (similar to those con- tained in an underwriting agreement); Pricing of PIPE Transactions • for variable/reset deals, the purchase agreement also may contain covenants requiring the future Will purchasers agree to a fixed price or a variable price? issuance of additional securities by the issuer at no PIPE transactions may be fixed price or variable/reset cost to the investor; price transactions. It is important to consider whether a variable/reset price transaction includes price protec- • the length of time given to the issuer to have the tion. Investors in variable/reset price deals seek resale registration declared effective (most often 60 “downside protection” by negotiating for rights that days); and protect the value of their investment in the event of a • whether there will be a time limit for filing of the downward price fluctuation. Issuers in variable/reset resale registration statement following execution of deals may negotiate a “cap” or “floor” to limit their the purchase agreements. exposure with respect to the maximum number of shares that may be issued as a result of stock price fluc- tuations or other conditions. Sharing Transaction Details with Potential Investors
How is a price set? Who may participate in PIPE transactions? The price is set through discussions between the place- Accredited investors are eligible to participate in ment agent and the issuer, as it is during the course of transactions. Funds, including mutual funds, pension an underwritten (firm commitment) offering. funds, hedge funds, etc., are frequent purchasers. Typically, s are priced at a modest discount to the More recently, venture funds have begun participating closing bid price for the stock. Often, in variable/reset in transactions. Venture funds typically negotiate transactions, the price is set based on a formula that for themselves additional covenants in the purchase relates to the average closing price of the stock over the agreements relating to corporate governance rights and several days preceding the pricing. information rights.
Who bears price risk? What information do investors receive? In a fixed price transaction, the purchaser bears the All of the investors receive the same information: a price risk during the period from execution of the pur- Private Placement Memorandum containing the chase agreement until the closing. In a variable/reset issuer’s Exchange Act documents. Investors do not price transaction, the price risk is shared between the receive projections or other information that has not investor and the company. Usually, the investor will been disclosed publicly. negotiate some price protection for itself. What should you tell investors before discussing details of the particular PIPE transaction? Other Negotiating Points in PIPE Transactions A is a private transaction. You will be sharing information (that the issuer is considering a financing In addition to negotiating specific carve outs for repre- transaction) with the potential investor that is not sentations and warranties, the placement agent, purchas- known to the market. Before you begin discussing the er, and issuer typically negotiate the following points: details of the issuer and the offering, you should men- • whether issuer’s counsel will be prepared to tion that it is a private transaction and obtain from the include a b- negative assurance in its opinion; investor an oral agreement that the investor will keep such information confidential and an acknowledgement • whether the issuer will be required to cause its independent auditor to furnish the placement that the investor understands how such confidential agent (if any) with a comfort letter at closing; information must be treated under the securities laws.
• whether there will be a limitation on the length of Will investors know what a PIPE transaction is? black-out periods; There are many misconceptions about transactions. • whether there will be penalty payments; Typically, within each institution, there is a compliance or legal person who is familiar with the structure. Using a Form - for the resale registration state- Requirements for an Issuer ment is cheaper and less time-consuming, since the Form - is less burdensome and may be updated by What kinds of issuers finance through PIPE transactions? the periodic filing of Exchange Act reports, without Historically, transactions have been used by the need to file post-effective amendments. An issuer issuers who had significant capital requirements, must be eligible to use Form - on a resale basis. including life science and biotech companies, real estate investment trusts, and technology companies. In What are the eligibility requirements for use of Form S-3 for recent years, as the volume of transactions has resales? increased, the variety of issuers coming to market with In order to use Form - for resales (secondary shares): transactions also has increased. Larger, more established issuers usually view transactions as an 1. an issuer must: alternative to shelf takedowns, traditional follow-on • be organized in the United States; offerings, or bought deals. Often, for larger, more • have a class of securities registered pursuant to established issuers, a transaction may be a means Section (b) of the Exchange Act or a class of of providing liquidity to existing stockholders. equity securities registered pursuant to Section (g) of the Exchange Act, or be required to file What are an issuer’s typical considerations relating to a PIPE reports pursuant to Section (d) of the transaction? Exchange Act; and • usually the issuer cannot issue more than 20% of • have been public and have timely filed all outstanding stock in the transaction without required filings for a period of at least calen- shareholder approval and prior notification to dar months immediately preceding the filing of exchanges; the Form -; and • the purchaser (not the issuer) bears market risk; 2. the issuer, and its consolidated and unconsolidat- • a short timetable provided there is no review; ed subsidiaries, must not, since the end of the last • the format is familiar to sophisticated institutional fiscal year for which certified financial statements investors; of the issuer and its consolidated subsidiaries were included in an Exchange Act report: (1) have • s typically involve a modest discount to mar- failed to make any required dividend or sinking ket price; fund payment on preferred stock, or (2) defaulted • the is comfortable with the format; and on the terms of any borrowing or on any long • s do not have any of the negative effects asso- term lease, which defaults in the aggregate are ciated with a “death spiral” preferred or an equity material to the financial position of the issuer and line of credit (discussed below). its consolidated and unconsolidated subsidiaries, taken as a whole. Must an issuer be eligible to use a Form S-3 registration statement on a primary basis in order to complete a PIPE May an issuer use an existing shelf registration statement to transaction? complete a PIPE transaction? No, an issuer need not be - eligible on a primary Generally, if issuers have a shelf registration statement basis in order to complete a transaction. An on file, it is a primary shelf registration statement cov- issuer may use a Form -,a Form -, or a Form - ering the sale by the issuer of newly issued securities. registration statement as a resale shelf registration For a , the issuer is required to file, and have statement in connection with a transaction. declared effective, a resale registration statement cover- ing the resale by the purchasers (a selling stock- tors or principal shareholders of the company equals holder shelf registration) from time to time of the secu- % or more of presently outstanding common stock; rities that were purchased in the transaction. or (2) the sale, issuance, or potential issuance by the company of common stock (or securities convertible Does a PIPE transaction require any prior approvals from reg- into common stock) equal to % or more of present- ulatory agencies or self-regulatory organizations? ly outstanding stock for less than the greater of book or A transaction may require prior approval from market value of the stock. the exchange on which the issuer’s common stock is Rule of the Nasdaq Marketplace Rules requires quoted if the transaction will be completed at a dis- that an issuer obtain shareholder approval in connection count and may result in the issuance of % or more with a transaction other than a public offering, involv- of the issuer’s outstanding capital stock. The company ing: (1) the sale, issuance or potential issuance by the should consider not only the effect of completing the issuer, at a price less than the greater of book or market proposed transaction, but also, if it has complet- value, of common stock (or securities convertible into ed other private transactions within the same six or exercisable for common stock) that, together with month period, the aggregate effect of such transactions, sales by officers, directors or substantial shareholders of all of which may be integrated. Each of the New York the company, equals 20% or more of common stock or Stock Exchange, the American Stock Exchange, and % or more of the voting power outstanding before Nasdaq has a similar requirement. the issuance; or (2) the sale, issuance, or potential A New York Stock Exchange listed company must issuance by the company, for less than the greater of comply with Rule .(c), which requires that the book or market value, of common stock (or securities issuer obtain shareholder approval prior to the issuance convertible into or exercisable for common stock) equal of common stock, or of securities convertible into or to % or more of the common stock or % or more exercisable for common stock, in any transaction or of the voting power outstanding before the issuance. series of related transactions if: (1) the common stock has, or will have upon issuance, voting power equal to, or in excess of, percent of the voting power out- Regulation FD Concerns standing before the issuance of such stock or of securi- ties convertible into or exercisable for common stock; How does an issuer ensure that it has complied with Regulation or (2) the number of shares of common stock to be FD in the context of conducting a PIPE transaction? issued is, or will be upon issuance, equal to, or in excess An issuer is owed a duty of confidence from its agents, of, percent of the number of shares of common stock such as its placement agent, accountants, and other sim- outstanding before the issuance of the common stock ilar participants in the process. Generally, an or of securities convertible into or exercisable for com- issuer does not share with potential investors any infor- mon stock. Shareholder approval is not required under mation that has not already been included in the this rule if the common stock is sold in a private financ- issuer’s Exchange Act reports. ing for cash, at a price at least as great as each of the A private placement memorandum for a book and market value of the issuer’s common stock. transaction usually contains the issuer’s Exchange Act Section of the American Stock Exchange reports, together with legal disclaimers. It is prudent to Company Guide requires that an issuer obtain share- limit the information contained in the private place- holder approval for a transaction involving (1) the sale, ment memorandum unless the issuer will be receiving issuance, or potential issuance by the company of com- signed confidentiality agreements. mon stock (or securities convertible into common Although the issuer is not sharing material nonpub- stock) at a price less than the greater of book or mar- lic information about the issuer’s business with poten- ket value which together with sales by officers, direc- tial investors, the issuer is sharing its plans con- cerning a potential financing transaction. The fact that version ratio of the security is tied to a percentage dis- the issuer is contemplating a transaction may count to the market price of the underlying common itself constitute material nonpublic information. stock at the time of conversion. As a result, the conver- The issuer should ensure that, before the placement sion price floats, or varies, based on the market price of agent reveals the issuer’s name, the placement agent the underlying common stock. The lower the market obtains an oral agreement from each potential purchas- price of the common stock at the time of conversion, er it contacts that information shared will be kept con- the greater the number of underlying shares that will fidential. This oral agreement may be documented be issued upon conversion of the security. subsequently through an acknowledgement and a covenant in the purchase agreement. What is a death spiral or toxic convert? The terms death spiral or toxic convert refer to a private- Equity Lines of Credit,“Future-Priced” Securities, ly placed convertible security that has a floating conver- and Death Spiral or Toxic Converts sion ratio, without a “floor.” The conversion ratio of the security adjusts based upon the market price of the com- What is an equity line of credit? pany’s security at some point in the future, usually the Under an equity line of credit, the company enters into time of conversion. Death spirals or toxic converts typi- an agency agreement with an investor pursuant to cally reset or adjust downward (to protect the investor) which the company has the right, during the term of only,not upward (to protect the company). Death spirals the equity line and subject to certain conditions, to put or toxic converts typically are priced at some discount to its securities to the investor. Some equity lines of cred- the company’s closing bid price over a period of days pre- it are completed using a shelf registration statement and ceding the pricing date. This price can be manipulated others are completed as private placements with an easily. Generally, the securities are placed by a hedge obligation to register the resale of the securities sold fund, instead of a broker-dealer. These securities may under the equity line. have very dilutive effects on the company’s stock.
What is a “future priced” security? Death spiral or toxic converts are “future priced” secu- By Anna T. Pinedo and James R. Tanenbaum, rities. Future priced securities are convertible securi- partners in the Securities Practice Group of Morrison & Foerster ties, often issued through a private placement or in a Regulation offering. The conversion price or con-