SPACs Have Revitalized a Misunderstood Small-Cap Financing Mechanism: PIPEs
According to research about the SPAC market by global law firm Freshfields, 69 percent of the consummated SPACS in 2020 were supported by PIPE financings. This presents a great opportunity to dispel some common myths about PIPEs.
PIPEs are toxic, death spirals. A PIPE is just an acronym which stands for Private Investment in Public Equity. In other words, a PIPE isn’t a corporate finance structure as much as it is an investing modality. A PIPE is effectuated when a single investor or group of investors are confidentially apprised of a publicly traded company’s imminent plans to raise capital. The ensuing financing could take the form of common stock, preferred stock, or some type of instrument that’s convertible into common stock.
Investors in PIPEs will short your stock. Maybe, but maybe not. One of the key differentiators between PIPEs and other common small-cap financings like RDs, CMPOs, and follow-on offerings1, is that investors in PIPEs are purchasing unregistered stock. In a shelf takedown, for example, a company has already filed a registration statement that’s been declared “effective” by the Securities and Exchange Commission. Investors who purchase registered stock can immediately resell it, if they wish, without any delay. Investors in a PIPE, however, have to wait for the company to file a resale registration statement covering the purchased shares; that is, there is no immediate market for shares purchased in a PIPE, and might not be for many months. If an investor purchases stock in a PIPE at a 20 percent discount to the previous day’s closing bid price, they might seek to short the amount of shares they purchased in order to lock in some or all of that unrealized gain, and that selling can certainly impact a company’s stock price. But keep a few things in mind: (1) not every stock has sufficient trading volume and borrowable shares to make shorting economically wise or possible; (2) some PIPEs are effectuated at or very close to the market price of the stock, thus minimizing any reason to short the stock in the near term; and (3) since PIPEs are confidential and don’t require filing a registration statement first, companies can often take advantage of a higher stock price from which to undertake a financing (i.e., short selling associated with a PIPE can drive down a stock price subsequent to a financing, but the company might have been able to sell stock at a higher price as a result).
PIPE pricing is always worse than selling registered stock. It can be, but not always when you look more closely. Consider a hypothetical biotech company ABC that experiences a material run up in their share price from $2.00 to $4.50. If ABC had no more room on their existing shelf registration and filed a new registration statement in order to capitalize on their elevated share price, the filing of the registration statement would likely impact their share price negatively (i.e., investors would be leery of the forthcoming dilution). Let’s say ABC’s stock price falls 15 percent when the registration statement is filed to $3.83, and then it takes 45 days to be declared effective. Given the passage of time, ABC’s stock falls further from $3.83 to $3.50. If ABC then sells stock at a 10 percent discount in a registered offering, it will have sold stock at $3.15. However, if ABC had sold stock in a PIPE at a 20 percent discount when the stock was at $4.50, they would have sold stock at $3.60. Yes, the discount was greater, but because ABC didn’t need to file a registration statement and wait for it to become effective, it sold stock at a higher price using a PIPE. Also, the capital would have been raised in a more timely manner.
It’s always the same handful of financiers. Often, but not always. It is definitely true that there is core group of special situation funds in the small-cap ecosystem that commonly invest in PIPEs. But companies also invest in other companies via PIPEs, as do long-biased, fundamental investors. The reason strategic investments often take the form of PIPEs is because long-term investors don’t care about receiving unregistered stock, and the issuer’s trading volume might not permit sizeable open market purchases. The most famous examples of strategic PIPEs are probably Warren Buffett’s investment in Goldman Sachs, and Oprah Winfrey’s investment in Weight Watchers.
Each and every year in the small-cap ecosystem, there are a plethora of PIPE financings that are usurious, or nearly so. But as is evidenced by the dozens of PIPEs in 2020 in the SPAC market, a PIPE does not need to be a “four letter” word. In fact, a PIPE might be a great financing choice depending upon the circumstances.
1 SCI members have access to a thorough rendering of small-cap financing structures in a piece entitled: “Comprehensive Overview of Small-Cap Financing Structures.”