What Are the 4 Types of Securities in PIPE Deals and Which One Is Right for Your Business?

Private Investment in Public Equity (PIPE) deals are a popular way for publicly traded companies to raise capital quickly, often without the extended timelines and regulatory hurdles of traditional public offerings.

In a PIPE deal, institutional investors or accredited investors buy securities directly from the company, offering immediate capital infusion. Understanding the types of securities used in PIPE deals is essential for companies seeking flexibility in raising funds while maintaining control over their capital structure.

Here are the four primary types of securities used in PIPE deals and the considerations for each: Privately-Placed Common Stock, Registered Common Stock, Convertible Shares/Debt, and Equity Line of Credit (ELC).

1. Privately-Placed Common Stock

In a PIPE deal involving privately-placed common stock, the company sells shares directly to investors at an agreed-upon price, often at a slight discount to the current market price. These shares are not immediately tradable and usually require a registration process before they can be resold in the public market.

Advantages of Privately-Placed Common Stock:

1. Quick Access to Capital: Privately-placed common stock PIPE deals offer a fast way to raise capital without going through the lengthy public offering process.

2. No Dilution of Voting Rights: Since common stock typically carries voting rights, existing shareholders maintain proportional control of the company unless a significant portion of shares is issued.

3. Straightforward Structure: The simplicity of issuing common stock can make it attractive to companies looking to avoid the complexities of more structured financing options.

Challenges of Privately-Placed Common Stock:

1. Discounted Pricing: Shares are often sold at a discount to the current market price to attract investors, which could signal financial weakness to the market.

2. Regulatory Registration: These shares cannot be resold until they are registered with the SEC, which can delay liquidity for investors.

3. Potential Dilution: Issuing more common stock dilutes the ownership stake of existing shareholders, which could impact stock price performance.

Privately-placed common stock is ideal for companies that need to raise capital quickly and are comfortable with issuing new equity but want to maintain a straightforward capital structure.

2. Registered Common Stock

Unlike privately-placed stock, registered common stock in a PIPE deal is immediately tradable upon issuance. The company registers the shares with the SEC in advance, allowing investors to resell their shares on the open market right after purchase.

Advantages of Registered Common Stock:

1. Immediate Liquidity for Investors: Since the shares are already registered, investors have the ability to trade them immediately, which can attract a broader base of potential investors.

2. Efficient Process: Pre-registering shares allows the company to avoid the delays and uncertainties of later regulatory filings, leading to faster completion of the deal.

3. Market Confidence: Offering registered common stock may demonstrate to the market that the company is confident in its financial health and is willing to provide immediate liquidity to investors.

Challenges of Registered Common Stock:

1. Lower Pricing: Because the stock is immediately tradable, investors may demand a larger discount to compensate for the lack of any holding period, which could further dilute the stock price.

2. Market Volatility: Immediate trading means that any negative market reactions to the issuance can impact the stock price more quickly.

3. Dilution: Like privately-placed common stock, issuing additional shares dilutes existing shareholder equity.

Registered common stock is suitable for companies seeking to attract investors who prioritize liquidity and for companies looking to streamline the fundraising process with minimal regulatory delay.

3. Convertible Shares/Debt

Convertible securities offer a hybrid approach, combining aspects of equity and debt. These securities can start as debt or preferred stock and convert into common stock at a later date, often at a predetermined price. Convertible PIPE deals allow companies to secure immediate capital without immediately issuing common stock.

Advantages of Convertible Shares/Debt:

1. Lower Initial Dilution: Since the securities begin as debt or preferred stock, the initial issuance doesn't dilute existing shareholders’ equity until they are converted into common stock.

2. Attractive to Investors: Convertible securities are appealing to investors because they offer downside protection in the form of interest payments (if structured as debt) or dividends (if structured as preferred stock), with the potential upside of converting to equity if the company performs well.

3. Flexible Structure: Companies can structure the conversion terms to fit their needs, whether it's setting a conversion price above the current market value or allowing conversion only under certain conditions.

Challenges of Convertible Shares/Debt:

1. Potential Dilution: Upon conversion, these securities can significantly dilute common shareholders, especially if the conversion price is set below the current stock price.

2. Complexity: Convertible deals require careful structuring and negotiation, making them more complex than standard equity or debt deals.

3. Interest or Dividend Payments: If structured as debt or preferred stock, the company may need to make interest or dividend payments, which can affect cash flow.

Convertible shares or debt are ideal for companies that want to raise capital with less immediate dilution and are comfortable managing the future conversion and potential dilution down the road.

4. Equity Line of Credit (ELC)

An Equity Line of Credit (ELC) allows companies to access capital over time, rather than receiving a lump sum upfront. In this type of PIPE deal, the company agrees to sell shares to the investor at regular intervals, often based on the current market price at the time of sale, up to a predetermined total amount.

Advantages of an ELC:

• Controlled Capital Access: An ELC provides flexibility by allowing companies to draw down capital as needed, reducing the risk of raising too much capital at once and diluting the stock unnecessarily.

• Market Pricing: Since the shares are typically sold at the current market price, companies don’t have to set a fixed price in advance, which can be beneficial if the stock price rises over time.

• Lower Immediate Dilution: The company only issues shares as they need capital, minimizing immediate dilution.

Challenges of an ELC:

1. Market Dependency: The amount of capital the company can raise is dependent on market conditions. A declining stock price could limit the company’s ability to access the full amount of the credit line.

2. Investor Control: Some ELCs allow investors to control the timing of share purchases, which could lead to unfavorable market timing or market overhang if the investor sells large blocks of shares at once.

3. Dilution Over Time: While the immediate dilution is lower, the company will gradually issue more shares as they draw on the credit line, which can lead to long-term dilution.

An ELC is suitable for companies that want to raise capital gradually and maintain flexibility in their financing strategy while minimizing upfront dilution.

Conclusion: Which PIPE Security is Right for Your Business?

Each of the four types of PIPE securities offers unique advantages and challenges, depending on your company's financial goals, capital needs, and market conditions.

Privately-placed common stock provides a simple and quick way to raise capital, while registered common stock offers immediate liquidity for investors.

Convertible securities allow for flexible financing with less upfront dilution, and Equity Lines of Credit (ELC) provide capital access over time with controlled dilution.

At Orgon Bank, we specialize in providing customized PIPE financing solutions that align with your company's goals. Whether you're looking to raise capital quickly or develop a flexible financing structure, our team of experts will guide you through the process and help you choose the security that best suits your business needs.