Done right, a private investment in public equity, or PIPE, could bring your business much-needed cash.
By C.J. Prince
Last fall, Kevan Casey, CEO of eLinear, had two specific near-term goals for his Houston-based technology solutions company: 1) to get listed on the American Stock Exchange, and 2) to expand, beginning with a new facility in Dallas. "We wanted to get off the [OTC] Bulletin Board as soon as possible so we could get in front of large institutional investors and start moving up the chain," says Casey, 32. One requirement for listing on the Amex is a minimum of $4 million in shareholder equity, of which eLinear had just $2.6 million.
With only $13.6 million in revenue for 2003, the company was too small for a secondary offering. So eLinear's management team opted instead to do a Private Investment in Public Equity (PIPE). PIPEs allow public companies to do a limited distribution of securities—in common stock or convertible debt—to accredited or institutional investors, quickly and quietly. "It's like a hybrid of private and public capital," says Steven Dresner, co-author of PIPEs: A Guide to Private Investments in Public Equity and publisher of The PIPEs Report. It is public equity, but "it's much like the traditional private equity market in that you have a select group of seasoned investors who can look at deals and make very quick decisions," says Dresner.
Efficiency is one of the PIPE's draws. PIPEs can be executed in weeks, where a secondary offering can take months. But the tight time frame allows for only limited due-diligence investigation of potential shareowners. And business owners often have to make a tough choice: either discount the stock—sometimes by as much as 70 percent—or offer registration rights that allow investors to sell sooner.
By closing three PIPE deals that raised more than $6 million, eLinear did both. The first, completed last December, raised $1 million from about 80 individual investors who received common stock at a deep discount but must hold the shares for at least a year. The second and third rounds, in January and February, brought in $5 million from mostly institutional investors—including hedge funds, which have been notorious shorters of stock in PIPE deals and which have recently come under the SEC microscope for illegal activity.
And eLinear's stock initially suffered from short selling, which came as a bit of a shock to Casey. "I was under the impression that their intentions were to grow with the company," he says of the round two and three investors.
Still, Casey says he wouldn't trade the compressed schedule. The capital infusion allowed the company to list on the Amex, open a new facility in Dallas and put away enough cash for several years. At the moment, the company is planning some large acquisitions, which will further enlarge its footprint, and is looking at a secondary offering 12 months out.
Going forward, however, Casey says he will turn a more skeptical eye on the motivations of potential investors. "I would try to get to know them better, have more one-on-one communication about where the company's going," he says.
That kind of investigation is absolutely critical to a successful PIPE, notes Harlan Kleiman, senior managing director with New York City-based investment bank C.E. Unterberg, Towbin and author of PIPES: The CEO's Guide to Successful Private Investments in Public Equities. "Money always has a face behind it," he says. "You must know the profile of the person who is buying that significant amount of your stock—or your company can get hurt."
But the PIPE itself is a neutral mechanism, Kleiman adds. It's only as good as those doing the deal. It helps that more big investment banks have been getting in on PIPE action, collectively raising $447 million in banking fees through PIPEs in 2003, an 80 percent increase over the prior year, according to Sagient Research Systems, a San Diego firm that tracks PIPE deals. And with $7 billion raised for companies in the first half of 2004—compared with $12 billion annually for 2002 and 2003—the PIPE market isn't slowing down.
Once seen as the scourge of capital raising, PIPEs are not just for troubled companies anymore, says Colin Blaydon, director of the Center for Private Equity and Entrepreneurship at Dartmouth College's Tuck School of Business. "It's been done enough times by strong, viable enterprises that it can be justified as a sensible alternative approach to financing."