NEW YORK – As public market investors continue to shun various small and mid-cap companies, scores of publicly traded businesses are now seeking private investments to strengthen both their boards and their balance sheets.
The reason is partly because these private deals are less complex than secondary public offerings and can be a savior for companies in distressed industries of the public market, such as biotechnology .
“It is difficult to get a public deal done, especially if the company is not a dotcom,” says Albert Bender, managing director at AG Edwards. “A lot of companies looking to raise anything less than $15 million to $20 million find PIPE deals (private investments in public equities) to be the most viable option simply for the speed in which the transactions can be done.”
Once the domain of offshore swindlers notorious for turning around 80% of a company’s stock in a debt spiral before running off with all the profits, PIPE transactions lately have received more attention from the legitimate investment community and traditional venture capital firms. Even publicly traded Internet companies have lured private investments as an alternative source of financing.
Last October, Highland Capital Partners and Vulcan Ventures combined to invest $10 million in online publisher Fatbrain.com. Highland General Partner Keith Benjamin, formerly an Internet analyst with BancBoston Robertson Stephens, joined the company’s board as part of the deal.
A.G. Edwards’ Bender cited an informal survey he conducted with venture capital firms to illustrate the venture industry’s softening stance toward after-market investment opportunities as indicative of VC acceptance of this mechanism. Approximately a year ago, he asked venture firms what they thought of PIPEs, and the response was that they were beginning to look at them. Now, he says, those same firms are doing deals.
This interest has motivated several early-stage companies to acquire publicly traded shells – often traded on the over-the-counter market – in hopes of complementing venture funding with whatever is generated in the public markets.
iParty, a New York-based online retailer of party supplies, has raised $27.9 million since acquiring a shell in 1997. iParty in December raised $5 million from buyout firm Hicks Muse Tate & Furst through a private placement of common stock prior to its move to the American Stock Exchange in January. Chief Executive Sal Perisano says publicly traded early-stage companies are not much different than companies that grow exclusively through venture financing.
“There is not much difference in being public or private because you are still raising money and the people that invest expect the same type of exit,” he says. “The one difference is that companies like ours don’t have access to the visibility of initial public offerings. But that comes later on when the company moves to a more visible market.”
But despite the financial flexibility a PIPE deal can bring to a company, a negative stigma still surrounds these transactions.
“There are two types of PIPEs – one done by a legitimate company with legitimate investors, and debt spirals funded by the same sleaze buckets that used to play to Reg S game,” says Kamal Mustafa, chairman of Bluestone Capital Partners.
Mustafa said deals should be avoided if a company’s stock price does not have high volume in relation to the size of the PIPE. Investors should stay away from taking preferred stock in a company selling at least 80% of its value in the public market, even if the company has honest intentions of using the capital to grow its business.
“Desperation does not excuse foolishness,” he added. “I wouldn’t touch these deals with a 10-foot pole.”
As PIPE deals become more common, regulators will be expected to establish more formal rules to govern the industry.
Joseph Bartlett, an attorney with Morrison & Foerster says that there is no firm set of rules from the Securities and Exchange Commission, and he believes if there is a market selloff, several Internet high flyers that fail to bring in sufficient revenue will be forced to raise PIPE deals just to survive.