ANN ARBOR – While PIPEs have been around for decades, an active public market in this type of security has existed only since the early 1990’s. In a study sponsored by the Center for Venture Capital and Private Equity Finance, the authors show that PIPEs have become an important source of financing for young, publicly-traded firms with poor operating performances that may limit alternative financing options. While nearly $100 billion in PIPE transactions have occurred since 1995, some experts estimate PIPEs will generate $25 billion in transactions this year alone.
Proposing that companies are motivated to issue these securities to minimize costs associated with asymmetric information, they find that both the security structure and the investor composition of a PIPE security matter in the subsequent performance of the issuing firm.
Poor post-issue performance is associated with securities where investors obtain significant re-pricing rights (variable conversion ratios and “resets”), which protect them from future stock price declines. What?s more, companies that obtain financing from hedge funds tend to under-perform companies that receive financing from other institutional investors, the study shows.
The authors argue that hedge funds act as “investors of last resort,” playing an important role in the market for young, high-risk companies with substantial asymmetric information. Hedge funds are willing to invest in such high-risk companies because they can protect against possible price declines in the issuing companies by either negotiating PIPE securities with re-pricing rights or by entering into short positions of the underlying stocks of the issuing companies.
