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PIPEs And Registered Direct Securities Offerings May Provide A Smart Alternative

To Public Companies Raising Additional Capital.


By Dario de Martino and Irwin M Rosenthal*

Public companies generally raise additional capital through follow-on public


offerings. However, in light of today’s depressed and volatile capital markets, an increasing
number of companies is seeking alternatives to traditional methods of financing.
As the capital requirements of issuers and the risk/return tolerance of investors
change and interrelate, it becomes more essential than ever to structure innovative financing
techniques that provide, among other things, lower costs, better timing and a reduced
disclosure and associated downward risk.
The market for follow-on offerings increased dramatically in 2008 with public
companies raising approximately $1.6 trillion. The US PIPE1 market totaled $177 billion in
2008, and despite a general capital markets decline in 2009, a total of almost $40 billion was
raised in 1,100 transactions2, with a clear increase in registered direct securities offerings
(“RDOs”) activity3.
The purpose of this article is to examine the advantages and disadvantages of PIPEs
and RDOs and to compare them to traditional follow-on offerings. You may wish to review
the chart on page 7 before proceeding, as it provides a fair summary of our analysis.

I. TRADITIONAL FOLLOW-ON OFFERINGS

Generally speaking, an underwritten follow-on public offering is a sale of securities


through a syndicate of underwriters on a firm-commitment basis. The offering is registered
with the Securities and Exchange Commission (“SEC”), and the securities are freely and
immediately transferable by their purchasers.
The traditional public offering process is time consuming. An issuer has to: 1)
prepare a registration statement, 2) file it with the SEC, 3) wait up to six weeks for SEC
comments, 4) prepare and file one or more pre-effective amendments to the registration
statement in order to respond to SEC comments, 5) seek and obtain SEC effectiveness of
the registration statement, 6) offer its securities to the public through underwriters, 7) price
the offering, 8) enter into underwriting agreement, and 9) finally close the transaction three
days after pricing. The entire process could take up to three months.

1
The acronym “PIPE”, which has assumed an important place in our corporate finance lexicon, refers to a
private investment in public equity. A universally accepted definition of a PIPE is hard to come by. A general
definition would be any privately negotiated equity or equity-linked direct investment in a public company.
2 See www.placementtracker.com, a research company that tracks private placements.
3 Deals in 2009 include $115MM Warburg Pincus’ investment in Webster Financial, $350MM BC Partners’

investment in Office Depot Inc., $300MM Olotoa Investments Inc.’s investment in ChinaTel Group Inc. and
$435MM Yucaipa Companies’ investment in Great Atlantic & Pacific Tea Co.
Client Alert

A follow-on public offering must be registered on a Form S-1, unless the company is
eligible to use a Form S-3.
The SEC created Form S-3 - and enacted the so-called shelf registration process - in
order to enable issuers to register the public sale or distribution of securities in advance of
considering one or more specific transactions and to take advantage of market opportunities.
However, not every issuer is eligible to use Form S-3. Only issuers: 1) who have been
timely in their periodic reporting for the last twelve months, 2) have not defaulted on any
senior debt or preferred stock, and 3) have a public float value of at least $75 million on any
one day within sixty calendar days prior to filing the registration statement, are eligible to file
a Form S-3 for the purpose of selling new securities.
Every report subsequently filed with the SEC is automatically incorporated, by
reference, into the shelf registration, thereby keeping the document up to date without any
special effort or additional filing.
Therefore, rather than covering a single, immediate offering of securities, a shelf
registration statement covers one or more offerings of securities, up to a dollar amount
specified in the registration statement.
Once the shelf registration becomes effective, the issuer has the option to issue the
securities under the shelf registration immediately or at a later point in time. That is, as the
issuer’s capital needs dictate or when market conditions are favorable, without the need to
restart the registration process for each offering.
When the issuer decides to offer securities under the shelf registration, the issuer files
supplements to the base prospectus and other documents already on file and proceeds with
an offering of all or some of the registered securities (a “shelf take-down”). This streamlines the
process and reduces the time needed for the offering, providing more flexibility to the issuer.
Underwritten public offerings, however, carry a lot of disadvantages. The main
features of a follow-on are that the new shares issued need to be registered and marketed ex-
ante, an underwriter is usually involved, and that usually triggers a dilutive effect.
Furthermore, when an issuer publicly announces an offering, there is a downward
pressure on the stock price and the market participants will attempt to short the issuer’s
stock.
Moreover, the transaction costs relating to the registration and underwriting process
as well as the length of time that can be required to complete registration, book-building,
pricing, and closing should be taken into account.
While the shelf process mitigates some of these expenses and timing issues, even a
shelf take-down can result in surprisingly high transaction costs and take an unacceptable
amount of time for an issuer that needs to take advantage of a narrow market window.

2
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This client alert is based on laws, rulings and other legislative materials, and should not be construed as legal advice or legal opinions on specific facts. Unless
otherwise noted, Gallet Dreyer & Berkey, LLP compiled all data in this report. The information in this client alert is not intended to create, and the
transmission and receipt of it does not constitute, a lawyer-client relationship.
Client Alert

II. PIPE TRANSACTIONS4


A follow-on offering can be a very expensive and lengthy capital raising technique.
As a result, even large and healthy companies are considering what was predominantly
utilized by micro-cap and small-cap companies with limited access to the capital markets,
PIPE transactions.
In a PIPE transaction, a public company - generally with the help of a placement
5
agent acting on a best efforts basis - enters into a private purchase of its primary and/or
secondary securities (usually common stock or preferred stock) with “accredited investors”6 who
irrevocably commit to purchase securities at a fixed price, not subject to market price
adjustments or fluctuating rations.
The private placement of securities is made possible by certain regulatory
exemptions defined by the SEC. Most PIPE offerings are generally conducted in accordance
with Section 4(2) and/or Regulation D (“Reg D”) - which establishes a safe harbor
exemption applicable to the private offers and sales of securities satisfying the specific
requirement of this rule- while also meeting the Securities Act Section (4)2 private placement
criteria.
PIPE investors agree to purchase illiquid securities, and the sale is conditioned on a
resale registration statement that the issuer undertakes to file with the SEC.

4 Although PIPE transactions are generally structured as plain-vanilla common stock, they can also be

structured in various ways depending upon an issuer’s objectives. In addition to common stock, they may
include convertible preferred stock, convertible debt, and structured equity line. It is worth noting that this
article mainly focuses on common stock transactions or traditional PIPEs.
5 The primary role of a placement agent is to connect issuers with investors and advise on various financing

alternatives. They are usually compensated on a success fee basis (3 to 10% of the capital raised) and, on a
retainer ranging from $10,000 to $100,000. “Finders” may also assist an issuer for deals that are too small or of
marginal quality to attract an established agent.
6 An accredited investor is any individual or institution deemed capable of understanding the financial risks

associated with the purchase of restricted securities. Pursuant to SEC Regulation D, Rule 501(a), an “accredited
investor” is:
1. a bank, insurance company, registered investment company, business development company, or small
business investment company;
2. an employee benefit plan, within the meaning of the Employee Retirement Income Security Act, if a
bank, insurance company, or registered investment adviser makes the investment decisions, or if the
plan has total assets in excess of $5 million;
3. a charitable organization, corporation, or partnership with assets exceeding $5 million;
4. a director, executive officer, or general partner of the company selling the securities;
5. a business in which all the equity owners are accredited investors;
6. a natural person who has individual net worth, or joint net worth with the person’s spouse, that
exceeds $1 million at the time of the purchase;
7. a natural person with income exceeding $200,000 in each of the two most recent years or joint income
with a spouse exceeding $300,000 for those years and a reasonable expectation of the same income
level in the current year; or
8. a trust with assets in excess of $5 million, not formed to acquire the securities offered, whose
purchases a sophisticated person makes.
3
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This client alert is based on laws, rulings and other legislative materials, and should not be construed as legal advice or legal opinions on specific facts. Unless
otherwise noted, Gallet Dreyer & Berkey, LLP compiled all data in this report. The information in this client alert is not intended to create, and the
transmission and receipt of it does not constitute, a lawyer-client relationship.
Client Alert

Funding, however, does not occur when the purchase agreement is executed, but
instead at closing. Closing generally occurs once various conditions are met, including the
SEC’s stated preparedness to declare the resale registration statement effective. In doing so,
investors are assured at the time of funding that a resale registration statement will be
effective and available for their use.
Timing. PIPE transactions can be completed relatively quickly. The average timing
may be just over one month, unless investors with a long-term strategy require a longer due
diligence. The issuer may commit to file and have declared effective a resale registration
statement immediately prior to, or promptly following, the closing of the private placement.
The timing of the registration is negotiated between the issuer and the investor/s and
because the shares purchased are not immediately transferable, the investors can demand a
discount to compensate for the illiquidity.
The issuer frequently uses a short-form (Form S-3) registration statement to register
the resale of the securities, even if the issuer would not be eligible to use that form for its
primary offerings.
Typically resale registration statement becomes effective 60 to 90 days after the initial
sale.
Discount. Investors normally negotiate a liquidity discount from around 8 to 12
percent below the market price prior to the announcement of the PIPE.
Costs. While PIPE transactions require relatively minimal legal documentation, they
do not avoid the costs associated with the registering of the securities, but merely delay them
until registration.
Traditional operative documents.
1. Securities Purchase Agreement. It is the agreement between the issuer and the
investor, by which the investor agrees to purchase and the issuer agrees to sell the
securities to be issued in the PIPE transaction. The document is generally prepared
by the investor’s or placement agent’s counsel.
2. Registration Rights Agreement. It is the agreement between the issuer and the
investor, by which the issuer undertakes to file a registration statement covering the
securities being issued.
3. Warrant Agreement (if any). It is the agreement between the issuer and the investor,
by which the investor will have the right to purchase additional securities of the
issuer during a specified period of time at a negotiated price.
4. Legal Opinion. Sets forth the issuer’s ability to enter into a binding agreement with
the investor as well as the legality of the sale of securities. It may also include a
statement from the issuer’s counsel with respect to the accuracy of the issuer’s public
filings or offering materials.
Disclosure. Disclosure of the transaction occurs only after the issuer receives definitive
purchase commitments, thus reducing the downward pressure. The stealth nature of PIPE
transactions is a key consideration for most companies that are concerned about the

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This client alert is based on laws, rulings and other legislative materials, and should not be construed as legal advice or legal opinions on specific facts. Unless
otherwise noted, Gallet Dreyer & Berkey, LLP compiled all data in this report. The information in this client alert is not intended to create, and the
transmission and receipt of it does not constitute, a lawyer-client relationship.
Client Alert

downward pressure on their stocks, particularly when an offering is dilutive to existing equity
holders. The public markets tend to react negatively to a discounted sale price, and often the
public trading price falls to around, or below, the price offered in the PIPE. Investors on the
other hand, bear price risk once they execute the purchase agreement, but they obtain almost
certainty of prompt liquidity.
Finally, in order to protect against investors shorting an issuer’s stock during the
negotiated period, an issuer frequently requires that the investor contractually agree, in
addition to any applicable securities law prohibitions, not to trade in its common stock until
the issuer has announced the deal or terminated negotiations.

III. REGISTERED DIRECT OFFERINGS

2009 experienced a clear increase in registered direct securities offerings activity.


An RDO is a negotiated sale by an issuer to one or more investors of securities that
have been registered pursuant to an effective shelf registration statement on Form S-3 (and
its analogous Form F-3 for foreign issuers) under Rule 415 of the Securities Act of 1933, as
amended (“Rule 415”).
Rule 415 permits an issuer to register a specific dollar or share amount of securities
without specifying the amount of any particular class or type of security or the timing or
method of the offering. The issuer may then sell any or all of the registered securities directly
to investors at a later date or dates of its choosing.
Unlike a typical firm commitment underwritten offering, an RDO is structured as a
“best efforts” offering. Accordingly, it involves a “placement agent” as opposed to an “underwriter”
who places the securities directly with investors, rather than directly purchasing the securities
itself and then reselling them to investors.
However, similar to an underwritten offering, the issuer in an RDO sells registered
securities that generally have no restrictions on resale. Because RDOs are fully registered
transactions, securities in these offerings can be sold to anyone, including retail investors.
RDOs typically are for common stock, although issuers may sell other types of
securities (e.g., convertible notes or warrants), and often do in combination with each other.
If the issuer has an effective shelf registration in place, then in order to use the shelf
registration statement for an RDO, an issuer must:

• be eligible to use the shelf registration for primary offerings;


• have sufficient capacity under the shelf to conduct the offering7;
• either: (i) have a market capitalization of at least $75 million, excluding shares held by
affiliates (its “public float”), or, (ii) for issuers with a market capitalization of less

7 In 2008 the SEC made it easier to conduct a shelf registration for smaller companies.
5
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This client alert is based on laws, rulings and other legislative materials, and should not be construed as legal advice or legal opinions on specific facts. Unless
otherwise noted, Gallet Dreyer & Berkey, LLP compiled all data in this report. The information in this client alert is not intended to create, and the
transmission and receipt of it does not constitute, a lawyer-client relationship.
Client Alert

than $75 million, sell no more than 33.33% of its public float in primary offerings
over any 12-month period; and
• the shelf must cover the type of securities the issuer plans to issue through the RDO.

The offering can be completed using a single-purpose registration statement if the issuer
does not have an effective shelf registration statement. If, however, the issuer has already a
universal shelf registration statement on file with the SEC, an RDO may be a means of
structuring a shelf takedown and a placement agent may be able to conduct a shelf takedown
as an RDO overnight.
Timing. If the issuer has an effective shelf registration statement available or is a Well-
Known Seasoned Issuer8 that can file an automatically effective shelf, the offering can be
priced and closed overnight or in just a few days.
Discount. Unlike securities sold in a PIPE transaction, the securities sold in a RDO
are fully liquid securities and therefore are not subject to the same liquidity discount.
Although there is some discount, an RDO will price at a lower discount-to-market than a
conventional
private transaction or a PIPE. The average discount offered in an RDO is only 4 to 6%.
Costs. Individual investors are not required to negotiate or sign a purchase agreement.
Usually, there will be no road show type presentations; rather, the placement agent may
organize a few individual meetings with the management.
In addition, even though an RDO requires a prospectus, the use of a shelf
registration process makes the drafting of the prospectus supplement much quicker than the
one for a conventional underwritten public offering. If the issuer and the placement agent
agree to use a preliminary prospectus supplement, this will contain only limited information.
However, it is worth noting that RDO are still public offerings, and therefore the
placement agent is subject to underwriter’s liability under the Securities Act of 1933, and will
need to conduct a thorough due diligence in a shorter time frame of an RDO.
Traditional operative documents.
1. Placement Agent Agreement. Similar to an underwriting agreement, it is the
agreement between the issuer and the placement agent, by which the placement
agent commits to place the securities with a group of investors, on a best effort
basis.

8 An issuer that meets all of the following requirements at some point during a 60-day period preceding the

date the issuer satisfies its obligation to update its shelf registration statement (generally the date of filing its
Form 10-K or Form 20-F): 1) It must be eligible to register a primary offering of its securities on Form S-3 or
Form F-3; 2) As of some date within 60 days of its eligibility determination date, it must have had an
outstanding minimum $700 million in worldwide market value of voting and non-voting equity held by non-
affiliates or have issued in the last three years at least $1 billion aggregate amount of non-convertible securities
other than common equity, in primary offerings for cash, not exchange; 3) It must not be an ineligible issuer.

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This client alert is based on laws, rulings and other legislative materials, and should not be construed as legal advice or legal opinions on specific facts. Unless
otherwise noted, Gallet Dreyer & Berkey, LLP compiled all data in this report. The information in this client alert is not intended to create, and the
transmission and receipt of it does not constitute, a lawyer-client relationship.
Client Alert

2. Subscription Agreement. It is the agreement between the issuer and the


investors, and governs the mechanics of the sale and the settlement thereof.
3. Escrow Agreement. It is executed in order to facilitate the transfer of funds
between each of the investors and the issuer.
4. Prospectus Supplement. It is filed with the SEC within two days of its first use
and discloses the terms of the offering, recent developments of the issuer, a
dilution table, a plan of distribution, and any other information that may need to
be disclosed.
5. Legal Opinion. Sets forth the issuer’s ability to enter into a binding agreement
with the investor as well as the legality of the sale of securities. It may also
include a statement from the issuer’s counsel with respect to the accuracy of the
issuer’s public filings and offering materials
Disclosure. Similar to PIPEs, RDOs are marketed and sold using a targeted marketing
approach that may be confidential. Therefore, RDOs avoid the risk of market price
fluctuation. Additionally, since an RDO is typically announced and priced on the same day, it
avoids speculative trading during the window between the announcement of an underwritten
public offering and the date of pricing and closing.

IV. CONCLUSION

For issuers that are able to avail themselves with a registered direct, such process
may offer some advantages of a PIPE without some of its disadvantages (see chart below).
However, an RDO is not always a better option than a PIPE or a follow-on
offerings. In addition, not all issuers are able to use Form S-3, and those who are may be
limited in the amount of securities they can issue. Nonetheless issuers should pay careful
consideration to the possibility of using an RDO since, especially in light of today’s volatile
markets, it may well prove to be the best alternative.

Timing Discount Costs Drop in share Dilution


price after
announcement
PIPE About one 8 to 12% Relatively Reduced Maybe a
month minimal concern
Registered Few days 4 to 6% Minimal Minimal Usually not a
Direct concern.

* If you are considering raising capital for your company, please contact Irwin Rosenthal or Dario de
Martino or any other attorney at Gallet Dreyer & Berkey, LLP with whom you regularly work. They may
be reached via e-mail at imr@gdblaw.com or ddm@gdblaw.com.
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___________________

This client alert is based on laws, rulings and other legislative materials, and should not be construed as legal advice or legal opinions on specific facts. Unless
otherwise noted, Gallet Dreyer & Berkey, LLP compiled all data in this report. The information in this client alert is not intended to create, and the
transmission and receipt of it does not constitute, a lawyer-client relationship.