In a US PIPE (Private Investment In Public Equity) transaction, investors purchase securities directly from a publicly traded company in a private placement, typically at a discount to the market price of the company's common stock. Because the sale of the securities is not pre-registered with the SEC, the securities are ‘restricted' and cannot be immediately resold by the investors into the public markets. Accordingly, the company will agree as part of the PIPE deal promptly to register the restricted securities with the SEC. Thus, the PIPE transaction can offer the company the speed and predictability of a private placement, while providing investors with a nearly liquid security at a discount from the current trading price.
In the UK the restrictions are a little more negotiable and flexible which points to what could be a very interesting opportunity for private investors to get in on the action, but should they? When researching a particular strategy it’s always prudent to see what the experts are doing. PIPE transactions funds are raised quickly, at a discount and usually because funding elsewhere is unavailable. This kind of funding is the remit and modus operandi of the private equity funds and venture capitalists.
From 1995 to 2004, VCs invested $8.3 billion in public firms through so-called PIPE (private investments in public equities) offerings, which accounted for about 8% of the PIPE market. PIPEs are attractive to venture capitalists due to their reasonable returns at a lower risk compared to investment in private firms. Many VCs believe that they can identify undervalued public companies and so have become more inclined to look at PIPE transactions. Particularly, some young public firms were taken to the public market during the 1999-2000 bubble period prematurely and had fallen on bad times, but retained promising business prospects and growth potential. To VCs, investments in these firms are natural extensions of their traditional investments in pre IPO stage private firms.
Also, PIPEs are less risky than traditional venture investments in private firms. PIPE candidates are more likely to turn a profit than early-stage startups, and they are likely to have more seasoned, professional management. Furthermore, PIPEs provide better liquidity than traditional venture investments. In a US PIPE, the issuer is required to file a registration statement with the SEC in order to make the equity resalable after a certain period following the closing (the “lock-up period”, typically 3-6 months). In the UK markets specifically AIM, lock ups can be negotiated between the parties, with the input of the NOMAD (Nominated Advisor) so this market can prove an even more attractive proposition, liquidity wise, than the US markets becuase financiers have more flexibility when negotiating.
Investors can sell the equity after the expiration of the lock-up period. This exit option makes PIPEs especially attractive to VCs when the IPO market and M&A market are cold, i.e., when the exit windows for investments in private firms are narrow or closed.
David Bardon of Swiss asset manager, Winterman Asset Management agrees "A number of our clients have recently scaled down their investment the pre-IPO investment markets, not because there is any less action in the IPO market, but many companies now offering pre-IPO opportunities to private investors seem to be offering poor quality deals and high valuations. We are being increasingly asked to source PIPE deals for our investors accounts and have launched a specific 'Managed PIPE Account' to fulfill this demand.
A Winterman Managed PIPE Account requires that a new client invests a minimum of £20,000 a maximum of £1,000,000, into a managed account set up with a leading Swiss Bank. This account is be managed by Winterman Asset Management on a discretionary basis. When an investment is made the bank applies for the securities in one block. If the PIPE is a traditional equity PIPE then the shares will be allocated to individual accounts of investors pro rata to the amount that has been invested. No more than 10% of the account is invested in any one PIPE deal. The investor will have a current account and a custody (broking) account. Any un-invested funds in the account can be withdrawn at any time and funds can be deposited in the account at any time.
So what of the performance of PIPES?
According to Sagient Research, which collects data on PIPEs, a total of 5,576 PIPE transactions between firms and all types of investors, with a total dollar amount of $86.8 billion, took place from 1995 to 2003.
This data was analysed and showed that returns vary greatly but a figure of 40% was given for VC lead deals and 10% for hedge fund lead deals over a 12 month period. The differential being attributed to the 'certification' of the VC. I.e. because the VC was involved people had more confidence in the company, hence the share price rise. Hedge funds were perhaps perceived as more short term investors.
Bardon says "This data is from 2003 and although it goes some way to explaining how PIPE's perform, we have to consider how the markets were in the early 2000's with dot com businesses skewing the figures. PIPEs are easily capable of returning 100% + on investment, however, there is risk to consider. We believe that a diversified portfolio of PIPEs will produce very good returns if held as an investment rather than a quick flip, which seems to be in agreeance with the conclusion reached by the data in this research paper."
Winterman are also able to set up tax structures that protect the growth of the investment in the account "Our partners have the necessary expertise to set up structures that make the account more tax efficient, we are also looking into the possibility of having an insurance wrapper for the account, but at the moment this is a work in progress."