By Benjamin Horney

Law360 (June 3, 2020, 6:17 PM EDT) -- Private investment in public equity, or PIPE, deals emerged as a popular transaction type for companies affected by the coronavirus pandemic, but they'll remain an option even once the turbulent economic times have subsided, meaning attorneys must understand the many complexities that can exist in putting together a PIPE.

PIPE deals involve public companies selling shares to private investors, including private equity firms. Under normal economic conditions, they are not the first capital raising tool that clients turn to, in part because they are generally likely to be more expensive than traditional debt financing, according to Andrew Bab, a corporate partner at Debevoise & Plimpton LLP.

"In many cases, you'd rather finance with debt," said Bab, who is a member of the firm's mergers and acquisitions and private equity groups and co-head of its health care and life sciences group.

When the economy stumbles, however, PIPEs usually become highly sought after as a way to shore up balance sheets by providing capital when other options, like initial public offerings, look less attractive. But attorneys should be aware that while clients might turn to PIPEs more often when facing financial hardship, such deals are always available and, depending on the circumstances, can be the right option even when the economy is humming along.

"PIPEs are really always part of the playbook, but a part you usually don't get to," said Uri Herzberg, a partner at Debevoise and member of the firm's mergers and acquisitions and private equity groups.

In the present environment, many of the companies doing PIPEs are the ones subject to limitations on what is known as their "baby shelf," according to Jocelyn Arel, a partner at Goodwin Procter LLP and member of the firm's corporate and technology companies groups.

The "baby shelf" rules of the U.S. Securities and Exchange Commission delineate that the maximum number of shares of common stock issuable by a company, either directly or through the conversion of equity-linked securities, cannot be greater than one-third of the company's public float.

"They've run out of being able to use that shelf, and there's still capital to raise," Arel said.

It's important for attorneys to keep in mind that major exchanges like the Nasdaq or New York Stock Exchange have limits on how much capital can be raised privately without a need to obtain shareholder approval. On those two exchanges, companies generally can't raise 20% or more of total voting securities, so many clients issue 19.9%. But attorneys shouldn't try to be too tricky by helping clients put forth multiple offerings at 19.9% in a short time frame, because instead of bringing in more capital, that will likely just lead to trouble.

According to Arel, stock exchanges have rules against such behavior, and they look at multiple PIPE deals within six months as being part of the same offering. Sometimes, depending on the circumstances, they'll look even further afield than six months.

"Exchanges will integrate offerings and deem them to be the same offering," she said. "There are basically anti-manipulation restrictions on those transactions. You can't just split up a deal into various components to avoid seeking stockholder approval."

Despite these and other drawbacks, such as a condensed timetable to do due diligence, private equity sponsors have shown an appetite for PIPEs for a number of reasons, including that they can be tailored to the sponsor's particular needs and investment thresholds, and can be a relatively easy way to gain a significant position in a promising public company. Often, these instruments may be part of a larger relationship between the sponsor and the issuer, Bab said.

From the issuer's perspective, the securities involved aren't publicly traded, so the company doesn't have to go through the entire securities law process, meaning no registration statement needs to be filed with the SEC.

"These instruments can be negotiated and funds obtained relatively quickly," Bab said.

And while PIPEs are often put together with a specific purpose and investor in mind, they aren't always directly the result of a client's request or lawyer's recommendation. Investment banks sometimes pitch PIPEs to clients, which then turn to a law firm for assistance.

"There are often circumstances where the client is actually doing a mini auction, trying to pitch, ultimately, a term sheet to a variety of sponsors to see which ones would be willing to move forward," Bab said.

Negotiations around PIPE deals are fluid. One week, an agreement might feature common stock or debt coupled with warrants, but the next week it'll be built around preferred stock or convertible bonds. And there are many details that need to be worked out, including how dividends will be distributed, how long the lockup period preventing the investor from selling the stock will last, or what the forced conversion rights will look like.

"It can be a moving target until the deal gets announced," Herzberg said.

Edwin O'Connor, a partner in Goodwin's life sciences group, said the negotiations around PIPEs are "a back-and-forth dialogue with substantive information that may not even be out there in the public market."

Not only must attorneys be adept at negotiating different aspects of a PIPE deal, they must be aware of how all the different clauses connect, including how one might affect another under certain circumstances.

"There's a lot of interplay between many of the concepts that are negotiated," Herzberg said. "If you focus on one or two and don't focus on some of the others, you run the risk that down the road there can be a surprising result. You can effectively lose some of the benefit of your bargain."

For example, forced conversion rights for preferred stock are a popular fixture in PIPE deals. They enable preferred securities to be converted into the common stock of the issuer, either automatically or at the issuer's discretion, only if the issuer's common stock trades above a certain price for a particular time period that has been determined by the parties.

But those protections can be undermined by events, like a merger or acquisition, that take place before the period has elapsed, or where the trading price of the common stock is below the agreed-upon threshold. Depending on the details of the merger agreement, preferred securities might effectively be converted into common stock before the investor would have liked. Unless, of course, the investor and their counsel were able to negotiate some kind of protection in the PIPE.

"Sometimes deals move so fast that the investor doesn't make sure all the different levers are hanging together to protect its ability to fully achieve its return," Herzberg said. "An initial reaction to an issue may be that it doesn't sound like a big deal, but after realizing how certain events can lead to an unintended result, the focus shifts to finding an alternative approach that works well for both the investor and the issuer."

Once the economy has fully recovered, there's no question PIPEs will be leaned on less by clients.

"We might see PIPEs higher up in the list of tools in one's toolkit, but I wouldn't expect that the intense activity we're seeing now would continue," Bab said.

However, history has shown that not only will they continue to be considered as clients mull capital-raising options, but PIPEs will always reemerge as one of the more popular deal types when there's significant economic disruption.

Perrie Weiner, a partner at Baker McKenzie who leads the firm's Los Angeles office and is chair of the firm's North America securities litigation group, has been litigating cases related to PIPE transactions for more than 15 years. The lawsuits Weiner litigated arose, in many cases, because of short-selling that occurred after a PIPE had been completed. His clients were typically hedge funds and broker-dealers.

"Of course, healthy companies rarely engaged in those financings, but current market conditions are similar to the late '90s tech bubble bursting, and the post-2008 Great Recession," Weiner said. "In those markets, hedge funds were the saviors. They gave companies limping along on life support, life."

--Editing by Brian Baresch and Emily Kokoll.

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