Private investments in public equity (PIPEs) are re-emerging as an attractive financing option for public companies (see Box, What is a PIPE Transaction?). According to PlacementTracker.com, the US PIPE market totaled $177 billion in 2008, up from $83 billion in 2007 and $29 billion in 2006. Although overall capital market activity has declined in 2009, the PIPE market was still active with $30 billion raised in the first six months.

Many factors have contributed to the increase in PIPE activity, including the scarcity and increased cost of credit and the difficulty of raising capital in the volatile market.

In addition, private equity funds, unable to raise sufficient debt financing for buyouts, have become more receptive to making minority investments through PIPEs. Deals in 2009 include Warburg Pincus' investment in Webster Financial, BC Partners' investment in Office Depot Inc., Olotoa Investments Inc.'s investment in ChinaTel Group Inc. and Yucaipa Companies' investment in Great Atlantic & Pacific Tea Co.

This article examines:

In general, PIPEs are a relatively expensive source of financing for a public company when compared to other capital-raising strategies that tend to have a lower cost of capital. Consequently, they are traditionally utilized by troubled micro-cap and small-cap companies that have limited capital-raising options.

Larger public companies have typically favored more traditional financing methods, such as underwritten public equity, debt and convertible securities offerings. However, recent market conditions have made it more expensive or difficult if not impossible for many companies, even large and healthy companies, to obtain financing through these traditional methods.

As a result, companies with maturing debt that they are unable to refinance and financial and other depository institutions striving to meet capital adequacy requirements are increasingly turning to PIPEs, which offer several advantages. One advantage is that these transactions can be completed relatively quickly (often in five weeks or less; however, some investors may require longer diligence periods (see Due diligence)) and require relatively minimal legal documentation.

Another advantage is that PIPEs are marketed and completed on a confidential basis. According to Stuart Bressman, a partner at Proskauer Rose LLP, "One of the benefits of PIPE-style marketing is that if a company goes to market and is unable to price a deal, it can be kept confidential as the company works out alternatives."

In the current volatile market, confidentiality is a key consideration for many companies. Confidentiality is particularly important for companies that are concerned about the market impact of announcing a public offering, particularly an offering which is dilutive to existing equity holders. By choosing to do a PIPE, the issuer avoids the immediate possibility that the market will put downward pressure on the issuer's stock price and potentially lower the price at which the securities are sold in the offering. In addition, convertible debt and convertible PIPEs are often effected at a premium to market so the issuers obtain the benefit of not doing an at-the-market offering (see Convertible debt/convertible preferred securities).

For more about the advantages and disadvantages of PIPEs, see Article, PIPES: Overview, What are PIPE Transactions?

Traditionally, PIPE investors tend to be public market investors that focus on short-term investments, such as hedge funds. Investors with a longer-term strategy, such as private equity and venture capital investors, have historically avoided PIPEs because of the inability to obtain control over the issuer.

For many private equity investors which traditionally invest in leveraged buyouts, the inability to obtain a control position in a company is one of the main reasons PIPEs are unattractive investments. However, in the current market, private equity investors are seeking new opportunities. "In the absence of leverage for acquisitions, private equity firms are deploying capital by identifying excellent companies in the industries where they have high levels of expertise, and in which they are willing to make significant, long-term minority investments," says Howard Sobel, a partner and co-head of the US private equity group at Latham & Watkins LLP. "In addition, board and committee representations, together with other provisions contained in the purchase agreement or the financing instrument itself, enable private equity firms to carefully monitor their investments."

Another reason why some private equity investors have increasingly been making investments in PIPEs is because of the reduced equity values of many public companies. "There has been resurgence in the market over the last couple of months, but at one point it was perceived that public companies were trading at well below their value," according to James Westra, a partner at Weil, Gotshal & Manges LLP.

Venture capital investors are also finding more opportunities in the PIPE market: "More venture capital investors are seeing the benefits of investing in companies that are already public. Why invest in a start-up when you can invest in a company that is already public and negotiate the same terms?" says Bressman.

In general, private equity and venture capital investors are investing in these companies with a longer-term view than traditional PIPE investors. But private equity and venture capital investors may have different end goals. According to Eleazer Klein, a partner at Schulte Roth & Zabel LLP, "The private equity mentality tends to be about getting to something bigger, perhaps buying the company down the road or helping the company do a merger. The venture capital mentality has been more about looking for a longer-term exit."

Private equity and venture capital investors have influenced PIPE transactions in the following ways:

It is unclear whether private equity and venture capital investors will continue to seek out PIPEs once the overall equity and debt markets improve and other investments become more attractive or available. It is also unclear whether large public companies will continue to consider PIPEs as a financing alternative once more traditional financing is more readily available at historic price levels. What is clear, however, is that the recent entrance of large companies as issuers and prominent institutions as investors not only reflects the mainstream acceptance of PIPEs, but underscores how PIPEs have developed into an efficient and useful technique for raising capital.

In particular, one technique under the PIPE umbrella that is becoming increasingly popular is registered direct offerings (see Box, Registered Direct Offerings). Although discussed as distinct from PIPEs, registered direct offerings share many similarities with PIPEs and are generally considered part of the PIPE market. "We are seeing more registered directs because certain investors do not want to get stuck with illiquid shares. In registered directs, the investor gets registered stock that is freely tradable," says Bressman.

The rise of registered direct offerings is just one example of how PIPEs can develop to meet the demands of the market. "What has happened in the PIPE space over the past decade is that the market is recognizing it as a flexible tool to raise capital and PIPEs are now on the menu of legitimate options," says Klein. Because of the many advantages of doing PIPEs it seems likely that large public companies may continue to use PIPEs even when more traditional options are available.