A private investment in public equity (PIPE) occurs when a public company sells its securities to accredited private investors. Doing so reduces the filing paperwork for the seller. Private investors are usually willing to engage in such a transaction when they are offered a discount from the market price of a company's securities, typically in the range of a 10% to 25% discount.
A major advantage of a PIPE is that it is considered a private investment by the Securities and Exchange Commission (SEC), so the shares do not have to be registered with the SEC. Since no registration is required, the offering can be completed quickly and with minimal administrative hassles. A further advantage for the issuing company is that shares are typically sold in large blocks under a PIPE transaction to longer-term and more knowledgeable investors.
However, there are some disadvantages to entering into a PIPE transaction, from the perspective of the issuer. Consider the following issues:
- Additional shares. The company may have to guarantee the issuance of additional shares to PIPE investors if the market price of the shares subsequently falls below a threshold amount.
- Price. Investors may demand an unusually low price, well below the market price of the securities.
- Warrants. Investors may demand that they also be granted warrants, so that they can participate in any upside growth in the price of the company's stock. Typical terms are to grant warrants for anywhere from 50% to 100% of the shares sold.
- Rapid sell-off. Unless the company is careful about which investors are allowed to buy shares in a PIPE deal, it may find that the investors sell off their shares as soon as possible, thereby driving down the market price of the stock.
- Short seller manipulation. If the company is obligated to issue more shares to investors if the stock price declines, short sellers could take advantage of the situation by continually driving down the stock price, which triggers the issuance of more and more shares. This death spiral PIPE can even result in majority ownership of the company by the PIPE investors. The scenario can be avoided by specifying a minimum stock price below which no additional compensatory shares will be issued.