Growing companies turn to PIPES. (Advertising Supplement: Corporate Expansion & Relocation).

In the current market environment, many companies seeking to raise capital are unable to access the public markets through traditional public offerings. This is especially true for smaller companies with a market capitalization of less than $500 million. However, for these companies, a PIPE (Private Investment in Public Equity) offering continues to be a viable alternative to a traditional public offering. According to PlacemenTracker.com, a company that monitors PIPEs, as of December 15th last year, there were 703 PIPE offerings, which raised $7.4 billion for companies with market capitalizations of less than $500 million. This compares to 823 offerings, which raised $7.9 billion for the same period in 2001.

A PIPE is a privately negotiated sale of unregistered securities by a public company to a select number of institutional and/or accredited investors. In contrast to traditional follow-on public offerings, a company registers the shares with the Securities and Exchange Commission after the sale is completed, at which time investors can then freely trade the securities.

Since the PIPE investors take a risk in not being able to sell the shares during the registration process, the shares sold in a PIPE offering are typically issued at a discount to the price of the publicly traded stock. Warrants may also be offered that allow the investor to buy additional shares at a fixed price.

Because a PIPE is privately negotiated between the company and its investors, they can be structured and tailored to the specific needs of both parties. In its most basic form, a traditional PIPE is structured as common stock issued to a limited number of institutional investors. Alternatively, a PIPE may be structured as a convertible preferred or a convertible debt security. These structures typically require a dividend (cash or common shares) or interest payment, as well as the right to convert the securities into common stock at a specified price, typically at a premium to the market price as of the date of the transaction. In the current market environment, many investors find the dividend or coupon features appealing.

In a difficult market environment, pursuing a traditional follow-on offering can be time consuming, expensive and risky. A PIPE, on the other hand, can be executed more quickly and with less cost, as the SEC filing occurs after the pricing, and the requirements and costs related to registration requirements, legal work, drafting sessions and roadshows are minimized.

This usually results in an offering being executed in a matter of weeks, rather than months, with minimal disruption to management. Additionally, because the offering remains private until the shares are registered, the company is able to test the market's receptiveness. Therefore, if the offering is unsuccessful, the company's reputation does not suffer, and it can avoid wasting valuable time and money.

Flexibility is another benefit of a PIPE offering, particularly in difficult market conditions. The different types of securities and terms available help bridge the gap between the company and investors. The company's investment bankers play a key role in helping to find quality investors who understand the company and industry, and support the company's long-term growth plans. The investment bankers, working with legal counsel, assist in structuring the terms of the PIPE to meet the company's objectives and avoid unfavorable terms, such as those associated with "toxic convertibles" or "death spirals". These particularly dangerous "floorless conversion" structures allow investors to reset the price downward if the stock price falls below the conversion price set at the time of issuance. This can encourage investors to short the stock in order to drive down the price, with the intent of receiving more shares upon conversion. The shorting and expected dilution upon conversion, in turn, creates additional sell ing pressure on the stock.

Wedbush Morgan Securities expects PIPEs to remain a popular investment vehicle for the foreseeable future. With the help of its investment bankers, a public company can assess the advantages and disadvantages of pursing either a PIPE or other capital raising alternatives with respect to cost, structure, execution and flexibility. The ultimate goal is to help the company raise capital at the best overall terms, while minimizing the risk for both the company and investors.

Michael Gardner, CFA, is managing director of Capital Markets for Wedbush Morgan Securities in Los Angeles.