Flood the Public Market
AUSTIN, Texas -- In a financial twist on an old
maxim, unsettled markets can make for strange bedfellows.
Consider, for example, venture capital and public
So-called PIPE financings, or private investments
in public equity, have been booming overall, with this year on pace
to be the second largest on record for such deals, trailing only
Meanwhile, some venture capitalists -- by their
nature private equity investors -- are increasingly engaging in PIPE
transactions along with more traditional PIPE players as mutual
funds and hedge funds.
"Venture capitalists have definitely been
getting more involved in PIPEs over the last year or two," said
Robert Kyle, executive vice president of DirectPlacement
Inc., which operates online financial database PlacementTracker.com.
A total of $4.7 billion in PIPE deals have been
inked thus far this year, according to PlacementTracker, easily on
pace to surpass last year's total of $15 billion. A record $24.4
billion in PIPE financings took place in 2000.
PlacementTracker doesn't break down PIPEs according
to the type of investor, but Mr. Kyle said PIPEs by VC firms
represent a small but clearly growing percentage of the
At its core, a PIPE is simply a private placement
of a large chunk of public stock, generally at a market discount
currently averaging about 15%. So-called "structured"
PIPEs include additional terms such as triggers that grant more
shares to an investor if a stock subsequently falters.
A Different Motive
The surge in PIPE deals in 2000, much of which took
place early in the year before the stock market began to crash, was
attributable partly to institutional investors who saw PIPEs as a
means of getting stakes in the highflying stocks they coveted
without driving up prices inordinately through large open-market
Opposite forces are fueling PIPE deals now,
however. Publicly traded companies with substantial financing needs
are increasingly looking to PIPEs in the wake of the crash because
the public markets have become hostile to secondary offerings and
other more standard funding sources.
Enter the venture capitalists.
Flush with cash, and with their own traditional
investment exit strategies -- initial public offerings or mergers --
moribund, some say the opportunities in public equity created by the
market downturn simply have been too good to pass up.
"Given the market's varying appetites ...
there are times when, in our view, these companies trade at
incredible discounts, certainly to what their highs have been,"
said Daniel Janney of Alta Partners, a San Francisco VC firm that
specializes in life sciences and information technology.
Alta Partners took part in its first PIPE in 2000
and now has done 16 such transactions within the biotech sector,
most recently taking the lead on a $14.1 million deal for a stake in
Orphan Medical Inc. that closed in December. That deal valued Orphan
stock at $8.25 a share, about a 16% discount to the market price at
While the vast majority of Alta Partners'
investments continue to involve private equity, the firm has created
two specialized "biopharma" funds that can put about half
their money into public equity.
Mr. Janney doesn't consider the public-equity deals
that his firm has engaged in to be significant departures from their
private-equity counterparts. Particularly within the biotech sector,
he said, the risk profiles for start-ups and for small publicly
traded companies are similar, as are the growth and management
challenges they face.
In addition, Alta Partners takes an active role in
its public companies, which Mr. Janney said justifies the VC
management fees that Alta charges its own limited partners.
"Really, this is public venture capital in the sense that, a
lot of times, these companies need as much help and work as a
private company," he said.
Representatives of Technology Crossover Ventures,
another VC firm that completed its first PIPE in 2000 and operates a
fund targeting public equity, said they also view such deals as mere
extensions of their traditional strategy. Technology Crossover
Ventures, based in Palo Alto, Calif., specializes in late-round
financing for technology start-ups. Like Alta Partners, Technology
Crossover's most recent PIPE came in December, when it took the lead
on a $23.3 million deal with eLoyalty Corp. That deal valued
eLoyalty at $5.10 a share, slightly less than a 15% discount to the
market price at the time, and it also involved convertible preferred
stock that will accrue 7% annual dividends.
"We are in the business of providing companies
with growth financing," said Jake Reynolds, a Technology
Crossover general partner. "So [doing PIPEs] isn't very
different from our traditional venture investments. Our goal is to
invest in great expansion and late-stage companies." He also
said he's not concerned about what in some instances has been
negative market sentiment toward PIPEs, fueled by a perception that
such deals can constitute "toxic" investments for
companies with few options.
Mr. Reynolds and other venture capitalists contend
they don't stipulate onerous PIPE terms because their goal -- the
same as in private equity -- is to get in at good valuations and
then nurture successful companies over the long haul. "We're
not trading the stock [received in a PIPE deal] on an active
basis," Mr. Reynolds said. "We're long-term investors, and
we're really looking to help a company grow to become leaders in
A Good Thing
Meanwhile, industry observers say any negative
stigma surrounding PIPEs overall is misplaced and has stemmed from a
lack of differentiation between standard PIPEs, which are straight
cash-for-stock swaps, and the structured PIPEs, which are more
complicated and often include unfavorable terms that can accurately
be described as "toxic" or "death-spiral"
Statistics from PlacementTracker.com show that the
percentage of structured PIPEs has fallen significantly in recent
years, registering only about 2% of the total thus far in 2002.
Indeed, far from reacting negatively, Perficient
Inc. Chief Executive Jack McDonald said investors have viewed his
company's PIPE in early January as "a strong vote of
confidence" from a savvy investment group, which included VC
firm Watershed Capital based in Austin. The $1.9 million deal valued
Perficient's stock at about a 30% discount to its $1.45-a-share
close at the time. But the stock climbed to $1.78 a share the next
day, and it recently has been trading above $1.60.
"It's a financing vehicle that allows us both
to do well," Mr. McDonald said, adding that his company turned
to a PIPE because of the poor market for secondary public offerings.
"There's clearly no market right now for secondary offerings
from small tech firms," he said. "For venture capitalists,
[PIPE deals] make sense because you've frankly got incredible values
out there in the public markets right now."