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Private Investment in Public Equity

A private investment in public equity is the investment of a private investment firm, mutual fund or other investor in the purchase of a public company’s stock at a price that is discounted to the current market price in order for the public company to raise capital. Traditionally, PIPEs involve common or preferred equity that is issued to the private investor (institutional) at a set price, however, there has been an increasing amount of structured PIPEs as well in today’s financial environment which includes the issuance of common or preferred shares of convertible debt. This particular type of capital raising endeavour is often preferable to doing a secondary offering as it requires less regulatory hurdles from the SEC and allows smaller to mid-sized public companies to gain ready access to capital as they are likely to find it harder than large public corporates to access the capital markets.

This type of deal is typically closed off to private investors (individual) as it works more to connect companies needing capital with companies who are in the business of investing in public companies either as their core or non-core operations. The PIPE itself allows the publicly traded company to access capital for its working capital, growth or acquisition needs and the company can acquire this capital in a matter of weeks, completely bypassing the legal and regulatory requirements of a traditional secondary offering. In the typical PIPE deal, a private placement occurs where investors buy the stock at a slightly discounted price to protect themselves against short-term price fluctuations. If the business being bought gets acquired or merges with another, then the PIPE buyers can take advantage of the dividends and capital gains payoff. In a structured PIPE on the other hand, debt securities that are convertible to common equity are sold. These often need greater levels of shareholder approval though, because if they contain a reset clause, then while new investors are protected on the downside, existing shareholders face dilutive risk in their shares.

There are multiple advantages and disadvantages to this type of transaction. The upside for companies is that they gain access to capital quickly and easily without a significant transaction cost. However, this ease and convenience also comes with its own risk-reward relationship. The PIPE investors may look to sell their stock within a short period of time which can lower market price. Beyond a certain level, the company would then be forced to issue any additional equity they need at the now lower valuation. In addition, while short sellers are a key part of the equity markets, they spell negative news for a PIPE issuer. Investors have often sold short the shares without having the ability to deliver the stock back, which once again results in a lower stock price.

In an ideal world, the PIPE issuer would look to issue their securities to more buy-and-hold- oriented investors with a track record of holding onto stock for a long time through economic cycles to realize long term growth. While they would require the same liquidity as short sellers, these investors are not active traders meaning that there is less volatility on the stock in the near to medium term. When conducting a PIPE, it is therefore important that the bank acting as the placement agent has deep knowledge of the private investor (institutional) base from which they can pick and choose who to allocate the equity offering to. The best quality placement agents would look to put their client needs first and build an order book around more long-term oriented clients rather than short term speculators. However, issuers do have to be aware of other agents who would look to sell to clients just for the fee they would receive.

In conclusion, while the PIPE deal offers several advantages for small to mid size companies in terms of ease to accessing the capital markets, there are several factors that need to be taken into consideration before they can be executed.

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