PIPE Deals Are A Plus During Pandemic But Can Have Pitfalls

By Benjamin Horney
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Law360 (May 12, 2020, 12:06 PM EDT) -- The coronavirus has drastically affected the public markets and caused companies to fall into financial hardship, and many businesses are turning to private investment in public equity, or PIPE, deals, which provide much-needed capital but can be tricky to put together and demand short turnarounds on due diligence.

PIPE deals, which involve public companies selling shares to private investors, are one of many options in the capital-raising tool set. But they've become more popular than usual as companies attempt to stay afloat amid a once-in-a-century pandemic that, as of Monday, had killed nearly 80,000 Americans, according to the Centers for Disease Control and Prevention

COVID-19 has also inflicted pain on the business world, forcing many companies to furlough or lay off workers as a way to cut costs. Roughly 20.5 million American workers lost their jobs in April, contributing to a national unemployment rate of 14.7%, according to the U.S. Department of Labor.

Companies are consulting with legal counsel on how to fortify their balance sheets in a turbulent period for the stock market, and PIPEs are increasingly becoming an option, even for clients that previously might not have considered such a transaction.

"They are part of the conversation with a lot more regularity than we have typically seen in ordinary market circumstances," said Daniel Webb, a partner at Simpson Thacher & Bartlett LLP. "I don't know if people are waking up in the morning thinking 'We want a PIPE.' They're waking up thinking 'We'd love to add some more liquidity to our balance sheet, and we don't know how long this market disruption is going to last.'"

Under stable market conditions, most companies chugging along in corporate America don't think about PIPEs as a major moneymaker, Webb explained. For public companies, they can come with trade-offs, including that PIPEs are typically sold at discounts. Normally, they are used as a way to garner additional funding for some significant event, such as an acquisition. 

But it has become difficult to obtain bank financing, and businesses that want to raise money right now are trying to avoid common stock offerings because of the volatility of the public markets. 

"The openness of the public markets has ebbed and flowed," said Jean Park, a capital markets attorney at Simpson Thacher and head of the firm's emerging growth companies practice. "Even in situations where they ultimately go a different route, there's a ton of interest in these products where there are varying degrees of structured instruments."

Private equity investors are among those that have pivoted to PIPEs. King & Spalding partner Rahul Patel told Law360 that those investors see the potential to ink transactions at attractive valuations for target companies that need liquidity.

"Absolutely, we're seeing private equity funds talk about this quite a bit," said Patel, who is co-chair of King & Spalding's global private equity and mergers and acquisitions practice.

According to Adam Weinstein, a partner at Sidley Austin LLP whose practice focuses on M&A and private equity, one of the biggest challenges to a PIPE deal is doing due diligence.

"With companies facing liquidity crunches and needing money quickly, there's a limited time to do due diligence," he said.

Thus, in the current environment, it's beneficial if the client seeking to do a PIPE deal has expertise in the industry of the target company, because it means doing diligence in a shortened time frame will not be as overwhelming.

"If you have a fund that has an understanding of the particular business or industry, you're better off," Weinstein said. 

Not all private equity clients will be set up to immediately implement a strategy focused on PIPE deals, according to Brien Wassner, a partner at Sidley Austin focused on M&A, private equity and restructuring. But those funds with flexible mandates, or multi-asset managers, typically have the freedom to pursue PIPE deals, even if they traditionally focus on leveraged buyouts or other private markets transactions.

"Different funds have different mandates," Wassner said. "Certain funds aren't mandated to play in the PIPE space."

Though PE people see opportunity in PIPEs during the downturn, it's not quite a perfect match, because the deals typically don't come with the same sort of control rights a private equity firm is accustomed to. Still, they can include components like board seats or consent rights for the investor, which is an area where much discussion among all sides is necessary.

"Those structural elements can be quite bespoke negotiations between the company and a particular investor," Park said.

Although PIPE deals are a hot commodity, they aren't a simple, one-size-fits-all type of transaction. In fact, there is plenty of variety on how such deals can be structured, beginning with the precise instrument being used. PIPE deals can feature common stock, convertible preferred stock, convertible debt, or a mixture of stock and debt types. It will all depend on what the client needs, what the investors want, and which protections are most important to both sides.

PIPEs can be structured in such a way that it doesn't require the consent of lenders and doesn't add to a company's overall debt load, Webb explained, and while such deals may require a client to give up some dilution on the equity side, unlike common stock, that dilution is done with the conversion above market price.

"My sense is that the most common transactions are secured bonds plus warrants or convertible preferred debt, sometimes with warrants," Webb said. "Processes will often start out a little product agnostic so the company can see where they can get the best value. What the investor prefers depends on their risk tolerance, and how they view upside vs. downside."

Investors can be particularly mindful of what their minimum return will be, especially in the current environment. Indeed, liquidity for the investor can be a complicated problem to address, highlighting the importance of attorneys capable of negotiating which instrument will be used and minute details of the agreement.

"There are a lot of ways you can solve that," Webb said. "Investors don't want to provide this financing without later getting something for their money."

--Editing by Rebecca Flanagan.

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