PIPEs a guide to private investments in public equity revised and updated edition

“A complete guide designed by qualified professionals to help companies, investment professionals, and investors better understand PIPEs as a financial tool.” – Mitch Hull President, Hul

“A complete guide designed by qualified professionals to help companies, investment professionals, and investors better understand PIPEs as a financial tool.”

– Mitch Hull President, Hull Capital Management, LLC

Private investments in public equity (PIPEs) offer a practical financing alternative for companies seeking capital and a unique asset class for investors For practitioners who know how to identify and execute trans- actions, PIPEs present a growing opportunity

This revised and updated guide presents the views, voices, and able expertise of leading practitioners from all specialties in the field The book is divided into three parts: “The Business of PIPEs,” which provides

invalu-a historicinvalu-al binvalu-ackdrop invalu-and overview; “Regulinvalu-atory Linvalu-andscinvalu-ape invalu-and Structurinvalu-al Alternatives,” which details the legal framework and transaction structures; and “Deal Flow,” which offers the investor’s perspective on negotiating deals

With detailed discussions, ranging from the origins of the marketplace and deal structures to legal considerations and due diligence, and from finding new opportunities to trading strategies, this book provides a clear window

to the inner workings of this active area of the small-cap market Investors, financial analysts, investment bankers, corporate and securities attorneys, and executives of public companies will find substantial value in the pages

of this book

Revised and Updated Edition

Edited by Steven Dresner with E Kurt Kim

“ A valuable and comprehensive update on the PIPEs market, with insights from the bankers, lawyers, and buyers This is an important reference for anyone working with PIPEs.”

Partner, Schulte Roth & Zabel LLP

“A complete guide designed by qualified professionals to help companies, investment professionals, and investors better understand PIPEs as a fi nan-cial tool.”

President, Hull Capital Management, LLC

“The PIPE space is made up of so many moving parts, but this book turns it all into a smooth-running machine Everyone in this business has learned to rely

on Steven and Kurt for clarity and understanding.”

Founder and Managing Partner, Enable Capital Management

“ Steve Dresner is the most knowledgeable person in the world of PIPEs

This PIPEs book is the bible of the industry and the source for anyone seeking straight answers regarding this otherwise complicated subject.”

Dian Griesel, PhD

Founder and Chairman, The Investor Relations Group

“ The first book to explain the trends in the PIPE industry, this revised and updated edition is essential reading to keep up with the changes and make the best use of this important fi nancing vehicle.”

Ramnarain Joseph Jaigobind

Managing Director, Global Equity Capital Markets, Maxim Group, LLC

“ The PIPEs market is one of the most dynamic areas of investment banking today Whether you are an investor or an issuer, banker, or student, this book is a must-read for understanding this increasingly important area of the equity and equity-linked capital markets I strongly recommend this publication to both market professionals and laypersons interested in the PIPEs market.”

Kim S Fennebresque

Chairman and CEO, Cowen and Company, LLC

“This is a must-read for attorneys, hedge funds, investment bankers, traders, and all companies looking to raise capital This book will become a handy reference to the investment community.”

Past president and founder, Nash Weiss & Co

Praise for the First Edition

“This book is a great reference that all PIPE investors should have in their offi ces.”

Cofounder and Managing Director, ProMed Management

“This collection of essays sheds light on the historical, regulatory, and transactional aspects of these often mysterious securities Both prac- titioners and students of the private equity industry should find this book valuable.”

Jacob H Schiff Professor of Investment Banking

Harvard Business School

“An impressive array of banking, venture capital, and legal professionals share their insights into this poorly understood but increasingly impor-tant financing alternative for smaller to midsize companies Firms and investment bankers looking to raise capital and investors looking for alternative investment approaches will find this authoritative reference

of great value.”

Professor of Finance and Chairman, Department of Finance

The George Washington University

involvement with PIPEs, or considering issuing or investing in PIPEs.” Michael B Pollack

Partner, Reed Smith LLP

“The first truly comprehensive book on PIPEs … as an active participant in the sector, I was impressed by their ability to bring in the best minds

in the business for their detailed thoughts on structuring, strategy, and pitfalls for the issuers, advisers, and investors Great job.”

Jonathan Silverstein

General Partner, OrbiMed Advisors LLC

“ How does one learn to utilize the most popular fi nancial tool for ing equity capital in the next decade? It is by reading PIPEs, the leading

rais-guide with the combined expertise of more than a dozen thought leaders,

sharing their cumulative knowledge in this fi eld.”

P Morgan Kash

Cofounder and Chairman, Two River Group Holdings

“ A highly useful treatise in an emerging area of the law.”

Joseph W Bartlett

Of Counsel, Fish & Richardson P.C

Founder and Chairman, VC Experts

“ In recent years, the importance of PIPEs has grown considerably, but reference material has lagged far behind This excellent book fills the gap

with a comprehensive treatment by highly qualifi ed contributors.”

by David N Feldman with contributions by Steven Dresner

Also available from Bloomberg Press

Edited by Benjamin Mark Cole

Hedge Fund of Funds Investing:

Edited by Arthur H Rosenbloom

by Charles Austin Stone and Anne Zissu

A Guide to Private Investments

1 2

No part of this book may be reproduced, stored in a retrieval system, or transmitted, in any form

or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher except in the case of brief quotations embodied in critical articles and reviews For information, please write: Permissions Department, Bloomberg Press, 731 Lexington Avenue, New York, NY 10022, U.S.A or send an e-mail to press@bloomberg.com

BLOOMBERG, BLOOMBERG ANYWHERE, BLOOMBERG.COM, BLOOMBERG MARKET

ESSENTIALS, Bloomberg Markets, BLOOMBERG NEWS, BLOOMBERG PRESS, BLOOMBERG

PROFESSIONAL, BLOOMBERG RADIO, BLOOMBERG TELEVISION, and BLOOMBERG TRADEBOOK are trademarks and service marks of Bloomberg Finance L.P (“BFLP”), a Delaware limited partnership, or its subsidiaries The BLOOMBERG PROFESSIONAL service (the “BPS”) is owned and distributed locally by BFLP and its subsidiaries in all jurisdictions other than Argentina, Bermuda, China, India, Japan, and Korea (the “BLP Countries”) BFLP is a wholly-owned subsidiary

of Bloomberg L.P (“BLP”) BLP provides BFLP with all global marketing and operational support and service for these products and distributes the BPS either directly or through a non-BFLP subsidiary in the BLP Countries All rights reserved

PrivateRaise, PrivateRaise.com, and Equity Private Placement (EPP) Database are trademarks of PrivateRaise, L.L.C

This publication contains the authors’ opinions and is designed to provide accurate and authoritative information It is sold with the understanding that the authors, publisher, and Bloomberg L.P are not engaged in rendering legal, accounting, investment-planning, or other professional advice The reader should seek the services of a qualified professional for such advice; the authors, publisher, and Bloomberg L.P cannot be held responsible for any loss incurred as a result of specific investments or planning decisions made by the reader

This book does not constitute or contain advice to enter into any transaction All legal and tory information is provided for informational purposes only and does not constitute advice on these matters Investments in PIPE securities involve significant risks and are suitable for only certain institutional “accredited investors,” as such term is defined in Rule 501(a) of Regulation D under the Securities Act of 1933, as amended Prospective issuers of and investors in PIPE securities should consult with their own legal and financial advisors before engaging in any transaction involving the issuance or purchase of a PIPE security

regula-First edition published 2003 Revised and updated edition published 2006

3 5 7 9 10 8 6 4 ISBN-13: 978-1-57660-194-5

The Library of Congress has cataloged the earlier printing as follows:

PIPEs : a guide to private investments in public equity / edited by Steven Dresner with E Kurt Kim Rev and updated ed

p

1 Private investments in public equity United States 2 Corporations United States Finance

I Title: Guide to private investments in public equity II Dresner, Steven III Kim, E Kurt HG4963.P57 2005

Acquired by Jared Kieling Edited by Tracy Tait

To Erica, Max, and Joshua

— S D

To Julia, Jonas, and Evalyn

—E K K

About the Contributors

Acknowledgments

Introduction 1

St e v e n D r e s n e r, The PIPEs Report

P A R T O N E | T H E B U S I N E S S O F P I P E S

1 Overview: An Emerging Market

2 The Marketplace: A Statistical Summary

Pr i vat e R a i s e ,

3 A Historical Perspective: The Bubble, Converts,

and the Birth of Structured PIPEs 53

4 The Players: Issuers, Investors, Agents

5 The Law: Legal and Regulatory Framework

6 Fundamental PIPEs: Typical Structures

and Transactions 129

E l e a z e r

7 Registered PIPEs: Registered Direct Transactions

Jo s e p h

8 Litigation Strategies: Managing Litigation Risk and

Addressing Other Investor Concerns 187

P A R T T H R E E | D E A L F LOW

9 Managing Risk: Securities Structures, Trading,

and Deal Documentation 205

St e v e

10 Due Diligence and Valuation Policy:

Caveat Emptor Squared 221

Steven Dresner is the founder of DealFlow Media, an online publishing,

database services, and event company with offices in New York, California, and Beijing DealFlow Media was founded in 2003 with the launch of

The PIPEs Report, a premier research tool for those in the equity private

place-ment market Since its inception, DealFlow Media has distinguished itself as a provider of independent research and analysis of alternative asset markets DealFlow Media has grown rapidly and now publishes a variety of alternative-investment reports, alternative-investment databases, and weekly newswires DealFlow Media also produces popular investment conferences including one

of Wall Street’s largest annual events, The PIPEs Conference, which is the ing forum for primary market deal structures specific to small- and mid-cap companies

lead-Prior to founding DealFlow Media, Dresner was an investment banker

at Ladenburg Thalmann & Co., and was the founder of VCOM ration, a technology development firm focused on the design of Internet-

Corpo-based telecommunications software Dresner is also a contributor to Reverse Mergers: Taking a Company Public Without an IPO by David N Feldman

(Bloomberg Press, 2006) Dresner has a BS in psychology from the George Washington University and both an MBA in finance and a graduate degree

in computer communications and networks from Pace University

E Kurt Kim is a partner and chief fi nancial officer of Promethean Asset Management LLC Promethean invests across asset classes in both the primary and secondary credit, volatility, and equity markets Kim has spent the past decade in various deal-making and advisory capacities and his experience spans a diverse range of industries and

a broad array of investment structures Prior to being named CFO

of Promethean, Kim was primarily focused on leading the fi rm’s set gathering efforts from 2004 to 2006 From 1997 to 2000, Kim was an investment manager at Promethean responsible for the origina-

as-ix

x About the Editors

tion, structuring, negotiation, and execution of investment nities involving equity private placements Kim founded PrivateRaise LLC (www.PrivateRaise.com), the leading research consultancy for comprehensive market intelligence and analysis pertaining to private placements of equity and equity-linked securities executed by public companies in March 2000 and served as chief executive offi cer until

opportu-July 2008 PrivateRaise.com was awarded Forbes’s 2002 Best of the

Web designation in the Financial Content Provider category (along with Thomson Financial, Bloomberg.com, and BigDough.com) Prior to joining Promethean in 1997, Kim worked as a strategy man-agement consultant for Mercer Management Consulting and Towers Perrin in New York He holds an MBA from the Wharton School of the University of Pennsylvania and a BA in economics and government from Wesleyan University

Daniel Carlson is the head of trading at BayStar Capital and has more

than twelve years of experience in the money management industry, most recently having been head of trading and portfolio manager at Coyote Capital, a SAC-backed biotechnology hedge fund Prior to that, Mr Carlson was head of trading at Husic Capital Management where he as-sisted in the management of hedge fund products Mr Carlson started

in the alternative investment field as head of trading and analyst at Azure Capital Partners, a venture capital/crossover fund investing in the technol-ogy industry From 1995 to 2000, Mr Carlson was a senior trader for RCM, where he specialized in trading small-cap and technology issues

Mr Carlson started his career on the Pacifi c Coast Stock Exchange where

he worked for four years, achieving the level of specialist on the trading

fl oor Mr Carlson graduated in 1989 from Tufts University with a degree

in economics

David N Feldman is the managing partner of Feldman Weinstein &

Smith LLP His practice focuses on corporate and securities matters and eral representation of numerous public and private companies, investment banks, venture capital firms, and high-net-worth individuals both in general representation and in transactional and fi nancing activities of all types Mr Feldman’s work also includes representation of many small and middle mar-ket private companies in general and transactional matters He is considered one of the country’s leading experts on reverse mergers Currently writing

gen-a book on the subject, he is gen-a frequent public spegen-aker, semingen-ar legen-ader, gen-and counsel on issues related to implementation of reverse mergers

Mr Feldman received a BS in economics from the Wharton School

of Business at the University of Pennsylvania in 1982 and his JD in 1985 from the University of Pennsylvania Law School He is an avid supporter of Wharton and the University of Pennsylvania and currently serves as chair-man of Wharton’s worldwide alumni association board He also is chair-

xi

xii About the Contributors

man and founder of the New York Business School Clubs, an association

of New York-area business school alumni groups Mr Feldman serves as a member of the Business Advisory Board of Sterling National Bank and he has previously been a member of or associated with the law firms of Feld-man & Ellenoff (which he cofounded); Pryor Cashman Sherman & Flynn; Reavis & McGrath (now Fulbright & Jaworski); and Rivkin Radler, LLP

Stewart Flink cofounded Crestview Capital in September 2000 He has

been actively involved in making PIPE investments in small-cap public companies since 1998 and has completed more than two hundred PIPE

transactions He has been quoted on Hedgefund.net and in The PIPEs port, and has lectured at several universities Prior to Crestview, he worked in

Re-the securities industry for seventeen years at Goldman Sachs, Bear Stearns, and Oppenheimer & Co He is on the alumni board of the Kellogg Gradu-ate School of Management at Northwestern University and president of the Board of Directors of the Chicagoland Jewish High School Mr Flink received his MBA from the Kellogg Graduate School of Management (’83) and a BA from Vanderbilt University (’78) He played on the professional tennis circuit in 1979–1980 and four years of varsity tennis at Vanderbilt

He lives in the Chicago area with his wife and four children

Brett Goetschius is the executive editor of The PIPEs Report, the leading

source of news and analysis on the equity private placement market He has covered the development of the public and private capital markets for more than fi fteen years as an editor and writer for numerous institutional

investment periodicals including Buyside, Wall Street Research Magazine, VentureEdge, Venture Capital Investment Review, The REIT Bulletin, and The Wall Street Mortgage Report

After receiving his BA in political science and writing from Drew versity, Brett worked as a reporter for newspapers in New Jersey includ-

Uni-ing the Morristown Daily Record, before joinUni-ing Crittenden Research in

California, were he spent several years developing some of the company’s most successful real estate finance newsletters Since leaving Crittenden he

has produced private equity publications for Reuters and Worth magazine,

and been quoted as an expert on the commercial real estate, venture

capi-tal, and private placement markets by Institutional Investor, National Real Estate Investor, the San Francisco Chronicle, and the Washington Post He

lives in Sonoma County, California, with his wife and two children

Lawrence R Goldfarb is the managing partner and cofounder of

Bay-Star Capital and has more than twenty years of investment banking, ing, and legal experience His specialties are bridging financial needs of

trad-growth companies by making direct investments and structuring tions that enable companies to grow and provide investor returns Mr Goldfarb began his career in 1984 as a tax attorney with the New York offices of Milbank, Tweed, Hadley & McCloy and thereafter Skadden, Arps, Slate, Meagher & Flom, LLP, where he provided tax analysis and consulting services in connection with a wide variety of complex transac-tions, including financings, mergers, and recapitalizations In 1987, Mr Goldfarb joined Credit Suisse First Boston Corporation as a Partner In

transac-1998, Mr Goldfarb formed BayStar Capital Management, LLC as a cle with which he could focus his efforts in funding growth-oriented, small-capitalization, publicly traded companies, an area that he had focused on while at Credit Suisse First Boston Mr Goldfarb is one of the leading experts, speakers, and writers on direct investments and has been asked

vehi-to speak at numerous industry events and conferences, including tional Investor’s Hedge Fund Roundtable and the Alternative Investments

Institu-Summit, in addition to other private equity and high-net-worth focused conferences Mr Goldfarb often serves as a guest lecturer on arbitrage strategies at numerous business schools, including Columbia and Berkeley, and has published articles and books on investing and arbitrage strategies

Mr Goldfarb received his BA degree from George Washington University and his law degree, cum laude, from Georgetown Law School

Richard E Gormley is a managing director at Cowen and Company,

LLC, where he co-heads the Private Equity Group and leads the fi rm’s Private Investments in Public Equity (PIPEs) and Registered Direct of-ferings (RDs) investment banking practice He joined SG Cowen from Rabobank International, where he was managing director and global head

of equity and debt private placements, as well as of high-yield debt nation During his nineteen-year career, he has structured, marketed, and closed private placement transactions for both private and public compa-nies approximating $6 billion; securities have included common stock, convertible debt and preferred stock, mezzanine securities with equity par-ticipation, senior and subordinated debt, and a variety of 144A securities Before joining Rabobank, Mr Gormley was a director at Nesbitt Burns Securities, Inc., where he started and managed the firm’s private equity investment banking practice Earlier he was a vice president at Security Pa-cific Merchant Bank/Burns Fry in its private placement group He began his career at Citibank’s North American Investment Bank Mr Gormley received a BA degree, magna cum laude, in philosophy and psychology from Cathedral College and an MA degree in theology and philosophy from Immaculate Conception Seminary

origi-xiv About the Contributors

Eleazer (Ele) Klein is a partner in the corporate department of Schulte

Roth & Zabel LLP, where he practices in the areas of securities law and mergers and acquisitions with a concentration in developing and imple-menting alternative investment structures for private equity investments

Mr Klein has been active in structuring and negotiating private ments in public equity since the early 1990s and typically works on well over one hundred PIPE and related transactions every year He has also worked with some of the major investment groups in developing convert-ible 144A and equity line products

invest-In addition to PIPEs, his areas of practice include Reg D, Reg S, and Rule 144A offerings; initial public offerings and secondary offerings; merg-ers and acquisitions; and venture capital financing Prior to joining the fi rm,

he worked at Davis Polk & Wardwell He received his law degree from Yale

Law School, where he was the senior editor of the Yale Law Journal, and

received a BS degree, summa cum laude, from Brooklyn College

James F O’Brien Jr is the founding partner of Promethean Capital

Group LLC and its affi liates, a privately held diversifi ed investment nization that has structured and funded direct investments in public com-panies since 1994 Prior to establishing Promethean, Mr O’Brien was a managing director in charge of strategic development and implementation for Fletcher Asset Management He began his career at Salomon Brothers

orga-as a financial analyst in the paper and forest products group Mr O’Brien graduated with a BA in economics from Bates College

Anna T Pinedo, a partner in Morrison & Foerster’s New York offi ce, has

concentrated her practice on securities and derivatives She represents ers, investment banks, financial intermediaries, and investors in fi nancing transactions, including public offerings and private placements of equity and debt securities, as well as structured notes and other structured prod-ucts Ms Pinedo works closely with financial institutions to create and structure innovative financing techniques, including new securities dis-tribution methodologies and financial products Ms Pinedo has particu-lar financing expertise in certain industries, including technology-based (Internet-related, life science, and biotech), telecommunications, health care, financial, REITs, and consumer finance Ms Pinedo has worked closely with foreign private issuers in their securities offerings in the United States and in the euro markets She also has worked with fi nan-cial institutions in connection with international offerings of equity and debt securities, equity- and credit-linked notes, and hybrid and structured products, as well as medium-term note and commercial paper programs

issu-In the derivatives area, Ms Pinedo counsels a number of major fi

nan-cial institutions acting as dealers and participants in the commodities and derivatives markets Ms Pinedo advises on structuring issues, as well as

on regulatory issues, monetization, and hedging techniques Ms Pinedo also has advised derivatives dealers regarding their Internet sites and other Internet and electronic signature/delivery issues Ms Pinedo received her BSFS degree from Georgetown University in 1990 In 1993, she received her JD from the University of Chicago

Joseph Smith, widely recognized as a leading expert in the field of private

investments in public equity, is a partner of Feldman Weinstein & Smith LLP, where he developed and perfected many of the most commonly used PIPE transaction structures He also has more than twenty years of expe-rience representing small- and mid-cap public and private companies in all phases of their development, from formation through IPO and sub-sequent merger and acquisition activity, and helping broker-dealers with their regulatory issues Mr Smith spent two years as a managing director and registered principal with Ladenburg Thalmann & Co., structuring and placing PIPE transactions with the leading team in that business

David W Stadinski is a principal in the equity capital markets group of

Piper Jaffray & Co where he leads the firm’s PIPEs and Registered Direct effort He joined Piper Jaffray from SG Cowen & Co where he was most recently a director in the private equity group focused on the origination and execution of PIPEs and Registered Directs Mr Stadinski provides client service and transaction management services to a broad range of Piper Jaffray’s corporate and institutional clients and has considerable expe-rience in equity, equity-linked, and debt capital-raising transactions, both public and private In his career, Mr Stadinski has completed more than fifty PIPEs and Registered Direct offerings raising proceeds in excess of

$1 billion Prior to joining the private equity group at SG Cowen, he was

a member of SG Cowen’s equity capital markets group where he worked

in an origination capacity focusing on public capital-raising transactions for emerging growth companies in the technology and health care sectors

Mr Stadinski earned his MBA in finance and information systems from New York University’s Stern School of Business and his BS in business administration from the University of Delaware

James R Tanenbaum, a partner of Morrison & Foerster LLP and Chair

of the firm’s Capital Markets Group, has concentrated his practice on porate finance and the structuring of complex domestic and international capital markets transactions He represents issuers, including some of the nation’s largest financial institutions, underwriters, agents, and other

cor-xvi About the Contributors

financial intermediaries, in public and private offerings of securities as well as issuers, investment banks, and purchasers in hybrid, mortgage-related, and derivative securities transactions Mr Tanenbaum works closely with leading investment banks to formulate new methodologies for securities offerings and to structure innovative fi nancial products

He also represents many technology-based companies, including many Israeli companies in the technology and biotech sectors Born in New York, NY, Mr Tanenbaum received his BA from Lehigh University in

1971, graduating summa cum laude In 1972, he received his MA from

Fletcher School of Law and Diplomacy of Tufts and Harvard Universities and received his JD in 1975 from the University of Pennsylvania where

he was an Editor of the University of Pennsylvania Law Review

Edward Totino is a partner in the securities litigation practice group

of DLA Piper US LLP He represents domestic and international banks and securities broker-dealers, as well as issuers and investment funds, in securities litigation and complex commercial litigation Mr Totino has an

AV peer rating from Martindale-Hubbell, indicating the highest levels of skill and integrity He has been awarded a Certificate of Appreciation by the judges of the Los Angeles Superior Court for service as a temporary judge for each year from 2001 through 2004, and has been named a Southern California Super Lawyer for 2005 in the area of securities litiga-

tion by the magazines Law and Politics and Los Angeles Articles written

by Mr Totino have appeared in The Journal of Investment Compliance and Andrews Derivatives Litigation Reporter In 1993, Mr Totino received his

law degree, magna cum laude, from Cornell Law School where he was a member of The Order of the Coif

Perrie M Weiner, a partner and international cochair of DLA Piper

US LLP’s securities litigation practice, represents private equity funds including hedge funds, broker-dealers, and issuers in SEC and NASD enforcement proceedings as well as in individual and class action secu-rities fraud and related claims He has a national practice with scores

of litigation victories and publications widely reported in the New York Law Journal, the Los Angeles Times, Hedgeworld, and The Economist,

among others Mr Weiner also represents private and public nies in a variety of industries, in both national and international busi-ness disputes In 2004, he was named a Southern California Super

compa-Lawyer by Los Angeles Magazine, ranked among the top 5 percent of

all lawyers in Southern California, and was one of only sixteen ties litigators to make that list In that same year, he was listed by the

securi-Los Angeles Daily Journal as one of California’s Top Mega-Rainmakers,

in the $10 million Club In 2005, he similarly was named a Southern

California Super Lawyer by Los Angeles Magazine

Mr Weiner also is an author, speaker, and commentator on edge securities litigation issues Most recently he has had securities articles

cutting-published in The Journal of Investment Compliance, Securities Litigation & Regulation, and Derivatives

Steven Winters is founder and managing member of Gemini Investment

Strategies, LLC, a multistrategy alternative investment firm Prior to ing Gemini, Mr Winters was a managing director and portfolio manager for The Palladin Group, LP, where he oversaw multistrategy and structured finance portfolios, sharing responsibility for more than $250 million of in-vestors’ capital, including investment decisions, trading, risk management, hedging, restructurings, and special situations In addition, he successfully structured, negotiated, and invested in numerous PIPEs He has worked

found-as director of trading for Promethean Investment Group, LLC and wfound-as an equity and derivatives trader for Bernard L Madoff Investment Securities, LLC Mr Winters developed equity, derivative, and tax arbitrage trading and investment strategies for Fletcher Asset Management and began his ca-reer in the corporate finance department at Salomon Brothers, where he specialized in raising capital and providing advisory services for mergers and acquisitions He holds a BS degree in economics from Cornell University

work of many people that this second edition went from idea to reality For their collaborative efforts, I offer my coauthors my sincere appre-ciation Through our work on this project and my affiliation with these people, I am able to keep a finger on the pulse of a business that is con-stantly changing

As both coauthor and coeditor, Kurt Kim continues to provide the technical knowledge gleaned from analyzing thousands of PIPE deals

I thank Kurt for being a steady guide, a close friend, and for supplying some great statistics

Many others have added to the quality of this text through their volvement with DealFlow Media, my publishing and events company

in-I thank everyone in both our New York and California offices, but most important, I thank Brett Goetschius, who has been a mentor in every sense of the word Brett, you’re one of the finest people I’ve ever worked with and I hope one day I might find the inner peace that you have Worthy of serious recognition is Jared Kieling at Bloomberg Press Jared listened attentively to my pitch for a second edition at my confer-ence in the fall of 2004 and helped make the idea an actual book only one short year later Jared, John Crutcher, Tracy Tait, and the rest of the team

at Bloomberg Press have once again exceeded expectations

Thanks to my father, who continues to be my biggest supporter (and I his biggest siphon in terms of lost billable hours) I look forward to tack-ling new projects with you Something tells me we’re just getting going

On the family front, thanks go to my mom for keeping me grounded And in the tradition of saving the best for last, all my love to my boys Max and Josh, and my wife Erica Words aren’t enough to express my gratitude

Steven Dresner

xix

abun-I would like to thank my coauthor, coeditor, and good friend, Steven Dresner, for his ceaseless dynamism From our very first meeting regard-ing the first edition of this book, his passion and dedication to this subject matter were unmistakable Our collaboration has resulted in a compelling intellectual journey and a lasting friendship

I would also like to express warm thanks to my colleagues and friends for their insightful criticisms and comments and for the gentle manner in which they were conveyed

At Bloomberg Press, Jared Kieling and Tracy Tait have continued to

be tolerant coaches while expertly guiding us through the editing and production process

Most important, I would like to give my deepest love and gratitude to

my wife Julia for her unwavering love and support, and to my precious children Jonas and Evalyn who astonished me with patience and under-standing well beyond their years

E Kurt Kim

steven dresner

The PI PEs Repor t

The use of PIPEs as a means to raise capital continues to grow as those

in the financial markets and managers of public companies gain increasing access to information on the topic of private investments in public equity Kurt Kim and I, along with our coauthors, have revised the original edi-tion of this book in order to keep the material fresh and relevant so that it can continue to serve as the definitive guide to PIPEs

As practitioners in this field, we continue to expand the boundaries

of private placements resulting from new types of fi nancing techniques and changes in the regulatory landscape As PIPEs evolve, it’s our hope that this updated book provides comprehensive, accurate, and accessible information for those working in, or merely interested in, this growing field of fi nance

PIPEs: A Guide to Private Investments in Public Equity is a collaborative

effort In addition to the first edition’s authors, several new practitioners

in the field have contributed their insight and analysis so that institutional investors, financial analysts, investment bankers, corporate attorneys, ex-ecutives of public companies, and even the general investing public will find substantial value in this second edition Through detailed discussions ranging from the origins of the marketplace to deal structures, from legal considerations to due diligence, and from finding opportunity to trading strategies, this book provides a rich perspective on the inner workings of

an active corner of Wall Street

What Is a PIPE?

A universally accepted defi nition of a PIPE has always been hard to come

by A general definition would be any privately negotiated equity or equity-linked investment in a public company But because of the in-creasing complexity of transactions, this description does not cover—and

1

certainly does not explain—the abundance of investment structures that fall under the broad heading of a PIPE These structures are examined throughout the book, but we can begin forming an understanding by de-fining the components of the acronym

Private A PIPE is a private transaction between a limited group of

in-vestors and a public company The private placement of securities is made possible by certain regulatory exemptions that have been defined by the Securities and Exchange Commission This notion of a PIPE as a privately negotiated transaction involving a limited distribution of securities is a key differentiator from public financings such as follow-on offerings, or what are frequently referred to as “secondaries.”

Investment A PIPE is a direct investment in a company Unlike

securi-ties purchased from other investors in a public market or trading exchange,

a PIPE involves the purchase of securities in a primary market, where new securities are offered to investors for the first time In a PIPE, securities are issued directly by a company, and the proceeds from investment benefi t that company For this reason, we refer to the company as an “issuer.”

Public A PIPE is used by a public company to raise capital There are,

in fact, similarities between private investments in public companies and private investments in private companies However, investments in public companies are governed by many unique securities regulations and laws The way in which these regulations and laws are interpreted make PIPEs

a discrete financing alternative, distinct from other forms of private and public investments

Equity A PIPE is an equity or equity-linked investment Equity can

simply be defined as ownership in a company Companies obtain capital through the issuance of equity, debt, or some combination of the two In this book, we are concerned with equity securities, securities that involve

an equity component, and securities that are convertible or exchangeable into equity

The illustration at right, borrowed from Kurt Kim’s Chapter 2, “The Marketplace: A Statistical Summary,” shows where PIPEs fit into the taxonomy of equity private placements Although this book discusses all

three types of equity private placements—Rule 144A, non-Rule 144A, and registered direct transactions—our emphasis is on PIPEs (what the editors

of this text define as non-Rule 144A and registered direct transactions)

A brief introduction to these investment structures is provided below

Rule 144A transactions, which are not considered PIPEs, are

pri-vate placements that involve equity or equity-linked securities sold only

to qualified institutional buyers (QIBs) with the understanding that these buyers may resell the securities to other QIBs The basic definition of a qualified institutional buyer is an institutional investor that owns and in-

vests, in the aggregate, at least $100 million in securities of issuers not affi l-i h l $ illi i i i f i ffil iated with that buyer There are other conditions, in addition to the $100 million requirement, that must be satisfied in order for an investor to be considered a QIB (see chapter 4) The vast majority of Rule 144A equity private placements are structured as either convertible debt or convertible equity In Chapter 5, “The Law: Legal and Regulatory Framework,” in addition to their updates on changing laws, regulations, and investment practices, James Tanenbaum and Anna Pinedo provide a cogent discussion

of the aspects of Rule 144A

Non-Rule 144A transactions, which are considered PIPEs, are

pri-vate placements involving equity or equity-linked securities executed in compliance with certain exemptions provided for under the Securities Act

of 1933, as amended Eleazer Klein explains these private placements in Chapter 6, “Fundamental PIPEs: Typical Structures and Transactions.” Representative deal structures associated with non-Rule 144A PIPEs in-clude common equity, convertible preferred equity, convertible debt, and straight debt with warrants

Registered direct transactions, which the editors of this text also

consider PIPEs—although others categorize them outside the scope of the PIPE universe—also involve the issuance of equity and equity-linked securities However, in contrast to non-Rule 144A PIPEs, the securities issued in a registered direct transaction have already been registered for

sale to investors through a primary registration statement declared tive by the Securities and Exchange Commission Although such issuances have characteristics similar to public offerings, many people consider them

effec-de facto PIPEs because of the negotiated nature of transactions and the limited distribution of securities Joseph Smith identifies the key issues involved in registered directs and details prevalent deal structures in Chap-ter 7, “Registered PIPEs: Registered Direct Transactions.” Included in his discussion are equity lines of credit, preregistered common and preferred equity, preregistered convertible debt and convertible preferred equity, and warrants

Changing market dynamics will forever impact the capital ments of issuers and the risk/return tolerances of investors The need to bridge the two promotes continuous innovation in the design of deals James O’Brien, in Chapter 3, “A Historical Perspective: The Bubble, Converts, and the Birth of Structured PIPEs,” explains how collaborative engineering among investors and issuers has yielded an expanding array of attractive financing techniques As the authors in this book reveal, there are as many PIPE structures as there are dealmakers willing to craft them David Feldman illustrates this point in his insightful treatise on how PIPEs can be combined with other transactions such as reverse mergers in Chapter 11, “Reverse Mergers + PIPEs: The New Small-Cap IPO.”

require-How to Use This Book

This book should be used as both a guide and a reference resource For this second edition, we maintained a three-part volume: “The Business

of PIPEs,” which provides a historical backdrop and statistical overview

of the industry; “Regulatory Landscape and Structural Alternatives,” which details the legal framework and transaction structures; and “Deal Flow,” which offers the investor’s perspective on fi nding deals and man-aging risk

As a guide, the book takes a systematic look at the business of private investments in public equity In Chapter 1, “Overview: An Emerging Market,” Richard Gormley provides the starting point for the reader’s journey into PIPEs His chapter presents an up-to-date snapshot of the industry and summarizes key characteristics of deal structures As the reader advances through the book, veteran investors such as Steven Win-ters bring the panorama into focus by explaining how to manage in-vestment opportunities Perrie Weiner and Edward Totino’s Chapter 8,

“Litigation Strategies: Managing Litigation Risk and Addressing Other Investor Concerns,” provides a level of insight into investment specifi cs that only experience offers

5

Introduction

In addition to serving as a guide, this book should be used as a erence tool Statistics and analysis of trends in Part 1, “The Business of PIPEs,” offer a quantitative depiction of the market both past and present The discussion of the legal framework in Part 2, “Regulatory Landscape and Structural Alternatives,” gives a road map of how we arrived at the current regulatory environment, including recent legal changes such as short selling rules that have signifi cantly altered the trading of PIPE secu-rities Term sheets, risk management strategies, and Stewart Flink’s “due diligence commandments” in Part 3 illustrate the process of putting to-gether and closing deals And of course, this second edition text contains

ref-an expref-anded glossary covering relevref-ant terminology along with a hensive index, so you can easily locate information

compre-As Larry Goldfarb and Daniel Carlson affirm in their Afterword, PIPEs continue to present a dynamic picture Since the first edition of this book was published in 2003, private investments in public equity have undeni-ably become a permanent part of corporate finance Along the way, this book has become required reading for anyone working in the multibillion dollar industry of private equity Whether you are an investment profes-sional or simply need a better understanding of private placements, my coauthors and I hope that this book serves as an invaluable reference and

as your guide to the world of PIPEs

P A R T T H R E E

nitty-grit-ty covers a lot of ground—far too much to cover in any single book Rather than attempt to reproduce in a few chapters mate- rial covering a long list of specific investments that have been addressed by innumerable authors in innumerable books, we se- lected a few specific investment categories that are (or should be) among those every adviser knows a good deal about: alternative investments, insurance investments, and those yet to be Obvi- ously, we’ve taken a bit of poetic license with the latter; how- ever, when we asked people as thoughtful and forward-looking

as Gary Gastineau and Craig Lazzara to write on a cutting-edge subject they consider important for advisers, we weren’t sur- prised when they provided a chapter not on an investment that exists today but on one that practitioners are likely to be dealing with tomorrow—if we’re lucky.

O N E

P A R T

Overview

An Emerging Market

Cowen and Company, LLC

The emergence of PIPEs, or Private Investments in Public Equity,

and RDs, or Registered Direct offerings, during the last fi ve years has altered the capital markets and corporate fi nance land-scape for small and midsize public companies PIPEs and RDs have become the preferred financing source for many issuers seeking expedi-tious access to competitively priced capital from institutional investors The growing participation of varied investors in this market likewise demonstrates the appeal of PIPEs and RDs as an attractive investment asset class This chapter provides a brief overview of the emerging PIPE and RD markets

A PIPE transaction is commonly considered to be the privately tiated sale of a public issuer’s equity or equity-linked securities to inves-tors, where the sale is conditioned upon a subsequent resale registration statement being filed with, and declared effective by, the Securities and Exchange Commission (SEC) This permits the immediate resale of the purchased securities upon effectiveness of the registration statement Be-cause PIPEs are private placements, they are governed by the guidelines found in Section 4(2) of the Securities Act of 1933, as amended, which provides an exemption from registration for an issuer’s transactions that do not involve any public offering Furthermore, SEC Regulation D (Reg D)

nego-† Publisher’s note: David Stadinski was a coauthor for the version of this chapter that appeared in the first edition of this book

9

In addition to the sale of unregistered securities, the PIPE market also includes the sale of registered securities to a limited number of investors These placements are commonly referred to as registered direct offerings (RDs) and include equity or equity-linked placements by issuers utilizing

a shelf (primary) registration statement that has been filed with and clared effective by the SEC

de-PIPEs and RDs provide an alternative financing vehicle for public companies in circumstances in which a public follow-on equity or equity-linked offering is not desirable, advisable, or possible PIPEs and RDs may be compelling for an issuer in one or more of the following circum-stances:

❑ The issuer hopes to execute a small transaction ($5 million to $50 million) on an accelerated basis, many times in as quickly as one or two weeks

❑ The issuer’s market capitalization is too small for a successful, ditional underwritten public equity or equity-linked transaction

tra-❑ Expansion of its shareholder base through targeted marketing is an important goal for the issuer

❑ The issuer’s industry sector is out of favor in the broader public equity markets

FIGURE 1.1 PIPE and RD Issuance by Industry Sector

(Percentage Based on Number of Issuers)

24%

($4.4 billion)

19%

($4.5 billion)

17%

($1.7 billion)

11

Overview: An Emerging Market

❑ The issuer seeks flexibility for the purpose of tailoring a fi nancing structure

❑ The issuer wants to avoid the up-front SEC registration process for timing-related reasons

❑ Confidentiality throughout the capital-raising transaction is an portant consideration for the issuer

im-PIPEs and RDs are typically offered to a limited number of accredited investors and to qualified institutional buyers (QIBs) Typical investors in-clude public crossover funds, mutual funds, private equity/sponsor funds, hedge funds, and financial institutions Typical issuers are growth com-panies such as those in the technology, health care, media, and consumer sectors, although many other types of companies in sectors such as energy, mining, manufacturing, finance, and financial services utilize the PIPEs market as well (see FIGURE 1.1)

Some History

The combined PIPE and RD market has recently experienced dramatic growth Since 2000, companies have raised more than $100 billion under a variety of structures Although transaction volume peaked in 2000 in con-cert with the Nasdaq index appreciation and related technology fi nancing activity, 2004 transaction volume was robust, approximating $22 billion (see FIGURE 1.2) Issuers at all stages of the business cycle, including cash-generating companies, are choosing to issue securities in this market The PIPE market as a vehicle for capital formation began more than two decades ago, when micro-cap companies facing uncertain fi nancing prospects could secure capital from technical-oriented hedge fund inves-tors as well as high-net-worth individual investors With the advent of SEC Regulation S (Reg S) in 1990, PIPEs became more popular because public companies were thereafter allowed to sell unregistered securities

to non-U.S entities, and these securities could be resold into the public markets after a forty-one day holding period These transactions were typi-cally structured as convertible preferred equity or convertible debt with variable or reset pricing features that often resulted in a deterioration of the issuer’s share price Transaction sizes ranged between $1 million and

$5 million, and the aggregate size of the PIPE market was no more than a few billion dollars Although Reg S was an effective financing platform for many companies, it was abused by some investors and issuers In 1997, the SEC amended Reg S in order to curb this abuse For a detailed discussion

of Reg S and its associated amendments, please refer to Chapter 5, “The Law: Legal and Regulatory Framework.”

By the mid- to late 1990s, the PIPE market began to mature as larger companies took advantage of the ease and certainty of fi nanc-ing it provided At that time, many biotechnology companies began to

fi nance via PIPEs because the public equity markets remained closed to them It was then that fundamental-oriented investors began to invest in PIPEs

With the increased utilization of universal shelf registration fi lings by issuers desiring fi nancing fl exibility, RDs emerged as an adjunct to the PIPE market Today, the combined PIPE/RD market is a well-recognized

fi nancing vehicle through which a variety of issuers successfully raise capital and in which both fundamental and technical investors actively participate Evidence of the market’s legitimacy includes the growing participation of larger issuers (who possess many fi nancing options) and blue chip institutional investors According to PlacementTracker.com, a research company that tracks private placements, in the fi rst six months

of 2005, excluding issuers with market capitalizations of less than $25 million, the average transaction size was approximately $20 million and common stock transactions represented the largest percentage of PIPEs The PIPE/RD market predominantly facilitates primary share issuance, but it can accommodate the sale of shares on a secondary basis as well At the current pace, 2005 PIPE/RD volume and number of deals is expected

FIGURE 1.2 2000–First Half 2005 Nasdaq and PIPE/RD Market

* Represents total proceeds raised in 1H 2004

500 1,000 1,500 2,000

2,500 Total Proceeds

Number of Offerings Nasdaq Composite

1H 2005 2004

2003 2002

13

Overview: An Emerging Market

Although the PIPE market is becoming more standardized each year (the proliferation of plain-vanilla common stock structures is an example of this trend), it remains a highly negotiated marketplace PIPEs can be structured in various ways depending upon an issuer’s objectives and profi le:

❑ Common stock (may include warrants/options)

❑ Convertible preferred stock (convertible into a fixed or variable number of shares; may include warrants/options)

❑ Convertible debt (convertible into a fixed or variable number of shares; may include warrants/options)

❑ Structured equity line (SEL)

Common stock PIPEs, which are commonly referred to as plain-vanilla

or straight equity PIPEs, are typically issued at a discount to the issuer’s current stock price Convertible preferred stock and convertible debt struc-tures are typically issued at an issuer’s current stock price or at a premium

to an issuer’s current stock price Structured equity lines are based on an issuer’s stock price, volume, and trading characteristics Convertible pre-ferred stock, convertible debt, and structured equity lines are each referred

to by some market participants as “structured PIPEs.”

According to PlacementTracker.com, in terms of the number of issues, common stock transactions accounted for approximately 70 percent of the combined PIPE/RD market in 2004, whereas in prior years convert-ible preferred stock and convertible debt offerings were more prevalent Common stock structures are expected to constitute the majority of such deals in the future

The trend toward common stock issuance has been caused, in part,

by higher quality, larger companies entering the PIPE market and by the widely publicized adverse effects of “death spiral” or “toxic” convertible PIPEs in several high-profile transactions These complicated securities, issued primarily by companies in dire need of funding, had negative con-sequences for both investors and issuers in the wake of the stock mar-ket collapse in 2000 In many cases, the issuing companies were head-ing toward bankruptcy prior to the issuance of their securities, and the death spiral/toxic securities played a large part in sealing their fate Death spiral/toxic transactions are typically structured as convertible securities with variable conversion pricing ratios, allowing investors to convert a fixed dollar amount into a floating share amount with no pricing fl oor Downward movements in issuers’ stock prices are often exacerbated by the existence of these variable conversion features, allowing investors to pur-

FIGURE 1.3 Summary of Structural Alternatives

SECURITY BENEFITS

Common • Plain-vanilla structure • May require (modest) warrant

Stock • Broad target investor base coverage and/or short-lived

• May be executed with options

limited marketing • Dilution consideration given

discounts

Convertible • Can result in less • May require (modest) warrant

Preferred expensive cost of capital coverage and/or short-lived

Stock than common stock— options

depending on terms • Dividend payment

• Convertible at market • Redemption/nonredemption

price or at a premium to features market price into a fixed or

variable number of shares

• May be executed with

Convertible • Can result in less expensive • May require (modest) warrant

Debt cost of capital than common coverage and/or short-lived

stock—depending on terms options

• Convertible at market • Interest payment

price or at a premium to • Leverage and repayment profile market price into a fixed or • Antidilution features

variable number of shares • May require financial covenants

• May be executed with • Senior or subordinated ranking

Structured • Ability to draw down funds • Securities must be registered

Equity Line on an as-needed basis via shelf filing prior to any

(subject to limitations) drawdowns

• Discounts typically smaller • Uncertainty of total funding—

than with common stock carve-outs based on

• May be executed without characteristics

marketing • Stock overhang perceptions

• Usually does not include • Narrow investor universe

warrant coverage • Only one investor participates

CONSIDERATIONS

limited marketing

limited marketing