Private Placement Investing (PIPEs)

Private placement investing, also known as private investments in public equity (PIPEs), is an additional channel for public companies to raise capital outside of the traditional ways of IPOs and secondary offerings.

In a recent article, we covered SPACs, or “blank check” companies, as a means of raising capital (for companies) and an alternative means to invest (for some investors). Namely, investors raise funds without knowing what company they’ll be investing in. Depending on how the deal is structured, the investor may receive a higher payout should the eventual public listing be a success (e.g., price rising by X percent once public). Accordingly, this would incentivize the investor to pick the highest-quality growth targets.

What’s driving the interest in private placement investing?

Private placement investing picked up with the fall in the traditional capital markets funding channels during 2020.

For a period spanning from early-March and into April 2020, the debt and equity markets were effectively closed to new issuances as the markets plunged.

Companies that would have otherwise issued bonds or convertible securities to raise capital found themselves in a difficult position. For many, revenue was drying up, a portion of the cost structure was fixed, and they had a limited amount of savings.

Many firms assume that their revenue is very unlikely to ever go to zero or close to it, and as a result it’s rare that they keep 6+ or more months in “true” emergency funds (i.e., their monthly fixed cost base multiplied by at least six).

This meant drawing down credit lines and having limited access to funding opportunities. This led some to the private markets and PIPE structure.

With private placements, institutional investors buy equity or equity-linked securities (e.g., convertible bonds, preferred stock, warrants) in a publicly traded company, but under a private transaction.

Participants in these types of deals include hedge funds, family offices, private equity funds, sovereign wealth funds, and occasionally pensions funds.

Benefits: Company vs. Investors

The company gets capital to fund operations. It often also receives strategic input from certain investors like private equity sponsors, who bring operational expertise and their network into helping the business succeed. Private equity investing traditionally involves boosting struggling businesses that are having issues growing or lack expense discipline.

The investor receives a stake in the company at a price less than a comparable public security, receiving a discount due to the lower liquidity. Moreover, the purchases of these securities don’t directly influence the price of existing issuances through the open market operations of buying and selling (i.e., via traditional trading activity).

Issuance of equity or equity-linked securities also avoids increasing leverage, as they’d have to do if raising capital through the debt markets.

Existing shareholders, however, will often look down on PIPE investments given they dilute (or provide a path to diluting) their personal ownership.

For that reason, PIPEs have some level of negative signaling effect, as they are often associated with stressed businesses that are otherwise shut out from traditional capital raising opportunities – even if it’s likely temporary, situational, and not directly the fault of the company’s operations.

2020’s private placement volume exceeded the typical $35-$40 billion typically seen in any given calendar year before the halfway point of the year. The PIPE structure saw similar popularity during the 2008 subprime crisis for a similar lack of access to traditional capital raising.

Will private placements persist even as liquidity has been restored and volatility drops off?

February 19, 2020 marked the peak of the 11-year bull market in US equities.

As markets went up and forward returns went down, more investors decided to sit out the rally, staying in cash rather than taking on a lot of risk for not much extra expected return.

Across hedge funds, family offices, private equity, and sovereign wealth funds there was upwards of $2 trillion in capital sitting ready for investment going into the February top.

With the virus-related dislocation, some of this was invested as valuations materially cheapened. Investors who are interested in private placements can obtain investments at attractive levels and on friendlier terms.

For example, this can mean having seniority in a company’s capital structure relative to common stockholders or being able to convert one’s securities into shares at a favorable predetermined price at some point in the future. And for investors of a certain size, it could include board seats to have strategic or operational input.

Which sectors are most popular for PIPE investments and how are these transactions structured?

During the 2008 financial crisis, private placement investing was mostly limited to the financial sector where most of the stress was occurring.

This time around, during 2020, a larger swath of the economy became systemic as a lot of the private economy was shut down to try to contain the virus.

Accordingly, there is more demand for unique funding structures in more sectors. The technology, media, and telecom (TMT) industries are seeing higher demand for private placements.

The structure of the transactions varies. They range from pure equity or equity-linked securities, like preferred equity, warrants, or convertible equity. They can also go down more toward the debt spectrum, such as debt plus warrants or convertible bonds.

If a company is looking to boost liquidity while limiting dilution, PIPE transactions can be a good fit toward the debt-like part of the spectrum. Given the structural flexibility, PIPEs allow companies to tailor capital raising to their particular needs.

PIPE investing in the SPAC space

Large institutions help drive blank-check mergers through PIPE fundraising rounds. 

PIPEs enable large investors like Fidelity and BlackRock to put money into the company going public through a SPAC, enabling a blank-check firm to merge with a company that’s several times larger.

PIPE financings have made SPAC mergers more competitive with standard initial public offerings. 

Grab (a type of Southeast Asian Uber) went public through a SPAC merger in a $40 billion deal that also listed Fidelity and BlackRock as PIPE investors. 

In all the largest SPAC mergers – including the ones that took WeWork, Social Finance, and Lucid Motors public – Blackrock and Fidelity are part of most of them and sometimes both. 

Other large investors like Franklin Templeton and T. Rowe Price are also common. They invest before any deal is announced and commonly are able to get in at prices that aren’t available to most smaller investors. 

ESG mandates may also have something to do with it. Many SPAC PIPE investments are tied to alternative energy and electric vehicle companies. Even now, these types of companies are small overall portions of portfolios and are looking to grow them over time, giving a leg up for certain types of companies over others.

Conclusion

PIPE transactions involve taking private stakes in public companies. Instead of issuing secondary offerings of shares or new debt securities in the traditional stock and bond offerings, the securities will involve private sales of securities to various types of investors.

These can include common shares, preferred shares, warrants, and/or convertible equity or bonds.

They typically provide the advantage of raising capital when traditional debt and equity channels are unavailable due to volatility or low market-wide valuations. Moreover, they can boost liquidity without immediately diluting existing stakeholders.

Investors typically like them when trying to negotiate favorable terms, such as receiving a higher position in the capital structure, ability to convert into a different security at a pre-set price, and/or receiving access to board seats to better control the investment (as private equity and other types of “activist” investors typically look to do).

Given greater-than-normal risks in how the virus washes through and its distributional impacts among industries, different countries, and over the course of time, private placement financing activity is likely to remain elevated.