In the current environment, as companies fear scarcity of capital and rush to draw on their existing credit lines, they should consider alternative sources of capital as part of their board deliberations and decision-making process. For public companies, private investments in public equity (PIPEs) are one such potential source of alternative financing. This post sets out the main considerations for PIPE transactions in the United States, highlighting areas relevant in the context of the current COVID-19 crisis.
How are PIPEs structured? When do they arise?
Type of security
Investments in convertible preferred securities are most common. Investments in common stock, warrants (sometimes together with an investment in preferred stock), or other equity or equity-like securities are also possible. Subject to tax considerations, issuers may prefer preferred stock to debt-like instruments to ensure equity treatment by rating agencies, which could become particularly relevant in the current market.
Typically, acquisition by the investor of newly issued securities in a private placement by the company (so investor can have input on terms of security), although can be structured as a private resale of shares by existing stockholders of the company.
Usually cash only. Non-cash consideration (e.g., transfer of assets) is possible, but rarely used.
Private equity funds historically have been the most common source of PIPE financing, but the number of PIPEs from hedge funds and other financial investors (e.g., sovereign wealth funds) has increased in recent years. Cash-rich corporate investors are also sometimes a source of funding for other corporations (and may take a larger role amid the current COVID-19 crisis), often in conjunction with entry into a commercial partnership. In addition, during times of economic recession (such in 2008 and 2009), the U.S. government has provided funding to U.S. public companies via PIPEs.
PIPEs can close quickly if they are structured to avoid requiring stockholder approval, as is often the case. They are most frequently used by issuers facing financial difficulties or that have urgent financing requirements, including to finance acquisitions. PIPEs are also used by IPO companies to issue common shares to an “anchor” investor alongside the public offering.
What approvals may be needed?
Stockholder Approval –The two major U.S. exchanges (NYSE and Nasdaq) require stockholder approval for any issuance of securities representing 20% or more of the common stock or voting power outstanding prior to the issuance (i.e., 16.67% of the pro forma common stock or voting power following issuance). Both exchanges have exceptions for above-market issuances and where the delay necessary to secure stockholder approval would seriously jeopardize the financial viability of the company and reliance by the company on the financial viability exception is approved by the audit committee of the board of directors. Very few companies meet the requirements of this latter exception, although it was used during the financial crisis of 2008-2009 and may be more widely available to companies in the current market environment, in light of the COVID-19 crisis.
Companies typically structure PIPEs to avoid requiring stockholder approval either by issuing securities that fall below the 20% threshold altogether or by issuing the excess securities that would otherwise trip the 20% threshold in the form of non-voting convertible securities or warrants that require stockholder approval prior to conversion or exercise into common stock or other voting securities (with the failure to obtain such approval typically entitling the investor to incremental interest, though issuers often object that such a structure may be coercive on stockholders in making their voting decision).
An issuer must have sufficient authorized shares of the type of stock proposed to be issued (or into which the security to be issued converts) and otherwise will need to amend its charter, typically with stockholder approval, to increase the authorized share capital. The issuer’s board will also want to confirm whether amendment of any existing stockholder rights plan (often called a “poison pill”) is required.
Board Approval – The board of directors of the company will need to approve any PIPE issuance and should be mindful that any such decision may be subject to heightened scrutiny if the investor obtains sufficient voting power, board representation and/or contractual rights (such as veto rights) to suggest it has acquired actual or negative control of the company. In undertaking any such decision, the board should revisit, with management and its advisors, the internal forecasts for the company and make a good-faith effort to assess future financial prospects, including liquidity and earnings. Additional procedural safeguards (such as approval by an independent committee of the board) may also be appropriate in certain contexts, particularly if the investor in the PIPE transaction is already represented on the board.
Regulatory Approvals – These will be transaction-specific and will depend among other things on the size of the investment, the industry sector and whether the transaction implicates national security concerns, and can include (i) expiration or early termination of the applicable waiting period under the Hart-Scott-Rodino Antitrust Act of 1952, as amended, and clearance under similar foreign antitrust laws if relevant thresholds are met, unless the investor can avail itself of an exemption for passive investments or is willing to receive non-voting securities or warrants initially (and not be able to convert or exercise into common stock) until such clearance is obtained; (ii) CFIUS (foreign investment) approval (in the context of the COVID-19 crisis, in addition to the industries that usually attract CFIUS scrutiny, there may be heightened focus on foreign investments in the healthcare and biotechnology industries); and (iii) other approvals, such as those specific to regulated industries (e.g., banking, insurance, gambling).
Other process points
No registration with the SEC or prospectus required, but the investor will receive restricted shares (see below).
The investor in a PIPE transaction will receive “restricted” shares that cannot be resold publicly for at least six months and that may be subject to further restrictions thereafter (including with respect to the number of shares that can be sold over any three-month period) if the investor is considered a “control person” (due to representation on the board or magnitude of voting power), in each case unless the resale is made under a registration statement. Accordingly, the company will typically commit to filing a registration statement for resales by the PIPE investor within a relatively short time period.
Issuer disclosure of transaction
The issuer must announce the PIPE transaction to the market (on a filing with the U.S. Securities Exchange Commission (the “SEC”)) and must include in that announcement disclosure of all of the material terms of any security or securities issued in the PIPE transaction, together with any other material terms or conditions of the sale (e.g., board representation, veto or other governance rights; transfer limitations).
Investor ownership disclosures
The investor must disclose (also on a filing with the SEC) its identity and the percentage of the company acquired if it acquires more than 5% of the outstanding common stock or voting power of the company on an as-converted basis. Unless the investor can take the position that it is a passive investor, it will generally have to update such filing with the SEC upon any transaction that causes its ownership percentage to fluctuate by 1% or more so long as it owns between 5% and 10% of the company and upon any purchase or sale transaction so long as its ownership exceeds 10%. The filing in each case must include a statement by the investor regarding any intentions to change or control the issuer and that statement is also subject to the prompt amendment requirement should such intentions change. If the investor qualifies as a passive investor, it can qualify for a short-form filing that only needs to be updated once a year. In the U.S., holders of 10% or more are also subject to the “short-swing profit” rules that require disgorgement of any profit from the sale of the issuer’s securities that can be matched against any purchase made within the prior six months.
Issuers are typically willing to allow potential PIPE investors to undertake limited due diligence beyond the information that is publicly available, but must be careful not to provide the investor with material, non-public information that has not and will not be announced to the market (which could include financial projections depending on their substance and time horizon). From the investor’s perspective, it will generally not want to receive material, non-public information that would restrict it from trading for an extended period unless it is given assurances that it will be cleansed within a short period.
Customary governance arrangements and other rights
Governance rights vary in U.S. PIPE transactions and are more typical in connection with the issuance of preferred stock, but can include (i) the right to appoint or nominate a certain number of directors, usually proportional to its fully-diluted ownership and subject to maintaining certain ownership levels; and (ii) veto rights, often including the right to approve amendments that materially and adversely impact the investor’s rights or economics, significant transactions, issuance of senior securities, incurrence of debt, payment of dividends and entry into material agreements.
PIPE investors also will typically request preemptive rights and economic protection in the case of future dilutive issuances, and the structure of the investment may include redemption rights in favor of the issuer or the investor.
An investor will typically agree to standstill obligations prohibiting it from acquiring additional securities or engaging in proxy fights for a specified period or until such investor’s ownership falls below a certain threshold. In addition, an investor may agree to covenants requiring it to vote in favor of the board’s nominees for director positions (or in line with the votes of the majority of the stockholders) as consideration for the board agreeing to nominate the investor’s designees or the granting of board appointment rights.
There is no limit on the size of the price discount in a U.S. PIPE issuance.
Typically, hedge-fund led PIPEs are priced at a modest discount to market to compensate for the temporary illiquidity of the securities. Private equity and strategic-investor led PIPEs may be sold at a lesser discount or occasionally at a premium to market price as they typically include more favorable investor rights, including governance rights.
Future transactions with the PIPE investors may be subject to “related party” transaction restrictions under debt agreements, governance documents and stock exchange listing rules.
Most states in the U.S. have enacted “anti-takeover” statutes that restrict the ability of a significant stockholder to enter into or effect a merger or other business combination with the corporation for a specified period of time. Depending on the relevant “anti-takeover” statute applicable to the issuer and whether the issuer has opted out of such statute (where possible to opt out), an investor may need to seek a waiver from the issuer board to preserve the ability to enter into or effect any such future transaction with the issuer.
If the PIPE investment is an initial step to making a subsequent takeover offer for the issuer, the investor must disclose its intentions in its ownership filings made with the SEC as described above.