A recently released academic study, from the University of Kansas and SUNY Albany, analyzed 3,230 private investments in public equity that closed between 1999 and 2007 and found that the stock of PIPE issuers associated with strategic investors significantly outperformed the stock of PIPE issuers associated with financial investors.
Strategic investors are defined as those seeking abnormal returns by adding value to the issuer (e.g., venture capital funds, private equity funds, corporations and other institutional investors), and financial investors as those seeking short-term cash profits (e.g., hedge funds, mutual funds and insurance companies). The study found that whether an investor had strategic or financial objectives materially influenced deal terms and, in turn, that deal terms had a significant effect on short and long-term stock performance.
Common PIPE deal terms were grouped into three main categories: cash flow rights, control rights and contractual protections. They were then further examined in terms of investor identity. The results look like this (note not all terms were present in all deals):
- Cash Flow Rights. The average share price discount was significantly lower in deals associated with strategic investors, but when interest or dividends were paid strategic investors often received higher rates. Warrant coverage was also less prevalent and the cumulative of all cash flow discounts was significantly lower in deals associated with strategic investors as compared to financial investors.
- Control Rights. In reviewing control rights, the study used percentage of stock ownership as a proxy for voting rights and found that following a PIPE strategic investors owned a greater percentage of company stock as compared to financial investors, and thus, by proxy, had greater voting rights. Less than 10% of the deals analyzed included board participation rights, but those that did were primarily associated with strategic investors.
- Contractual Protections. The prevalence of registration rights, anti-dilution protection and redemption rights were significantly greater in deals associated with financial investors as compared to strategic investors. The prevalence of rights of first refusal/investor call options were also greater in deals associated with financial investors as compared to strategic investors. Only approximately 10% of the deals analyzed included company forced conversion rights, but those that did were primarily associated with financial investors.
Another interesting bit of information from the study: deal terms were more investor-friendly when a placement agent was involved.
So, overall, strategic investors typically seek more control rights, less cash flow rights and less downside protection as compared to financial investors, and PIPEs associated with strategic investors outperform those associated with financial investors over the short and long-term.