There have been a number of PIPE Funds that have gained notoriety over the years because of the gains they have been able to attain with this strategy.
It is now categorized as a separate hedge fund strategy along with others like long only, long/short market neutral, special situations, emerging markets and distressed equity.
The strategy is also sometimes referred to as “Reg D” which is short for “Regulation D”.
Domestic funds in the U.S. are usually set up as limited partnerships while offshore funds are typically set up as corporations for tax purposes. Here is some more information if you are considering a Hedge Fund Start-up.
PIPE FUND OVERVIEW:
First of all, PIPE stands for Private Investment in Public Equity. Private Investment means the capital comes from a private source like a hedge fund, wealthy investor or investment banker.
Public Equity simply means it is a publicly traded company, so the PIPE Hedge Fund is purchasing stock, usually restricted common stock, in a publicly listed company. So a PIPE Fund is a hedge fund that makes investments in publicly listed companies.
About ten years ago there were only a few of these Funds around. The annual returns for most of these Funds were well above average, and so quite a few more were formed by other managers. Some of them failed because they were run by managers that either lacked the years of experience needed to run such a Fund or they took on too much risk and made investments that were very illiquid.
Second, PIPE Funds are formed either as limited partnerships, if they are made of U.S. investors that are not tax exempt, or offshore corporations, if they are made up of offshore investors or U.S. tax exempt investors.
U.S. tax exempt investors are usually endowments, pension plans and charitable trusts. If the PIPE Fund is set up properly U.S. tax exempt investors can take advantage of investing in these and other types of hedge funds. Of course before investing in any hedge, investors need to conduct thorough due diligence. Some investors hire a hedge fund attorney to help them perform due diligence and discuss issues that evolve during that process.
Third, these investments in public companies can take a number of different forms and structures. They can be straight common stock with a discount to market, common stock with a discount and a reset feature, convertible preferred stock, convertible debentures, a self amortizing loan or even a Warrant structure.
Sometimes these structures have a built in “hedge” sometimes they don’t. Obviously, investors in such Funds would prefer to have a hedge, but it is not always possible and some of the PIPE investments in companies with good balance sheets won’t have a reset or floorless convertible feature.
Another interesting thing about PIPE Funds is that they can structure their investments in a number of different ways. A PIPE investment can be structured as a straight common stock investment or it can be a convertible debenture, convertible preferred, or a unit comprised of common stock and warrants. Some of my PIPE fund clients and now more active than ever since commercial credit and bank lending has tightened up considerably.
Microcap companies with market capitalizations under $300 Million have always had difficulty obtaining funding. They usually don’t have significant assets to get bank financing. Microcaps have traditionally relied on hedge funds, private investors such as wealthy individuals, and private equity firms to raise capital.
The economic crisis of 2008 has brought its share of casualties such as Bear Stearns and Lehman Brothers. Bank lending is difficult to obtain and midcap and largecap companies are even obtaining PIPE funding. The most significant PIPE transaction was the Berkshire Hathaway PIPE investment in Goldman Sachs.
Corporate funding based on PIPE structures is likely to increase in 2010 and beyond, so companies in need of working capital or funding for acquisitions need to educate themselves in this area and develop the right contacts. It’s always better to line up funding in advance of when it is actually needed.
Over the years I have seen too many companies wait until it was almost too late to close on the funding they needed.
About the Author
Alvin Donovan, Institutional investor partner substantial funds, bestselling author, hedge fund industry pioneer, completed several billion dollars transactions, consultant to fortune 500 companies, faculty member most of the world’s largest management institutes, raised over USD$1.5 billion for funds www.alvindonovan.com
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