Pipes: Private Equity Investments in Distressed Firms
9 Pages Posted: 21 Oct 2008
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Pipes: Private Equity Investments in Distressed Firms
Pipes: Private Equity Investments in Distressed Firms
Abstract
This technical note describes the basic features of a new type of security called private investment in public entities (PIPEs). Increasingly, public companies in need of financing are raising capital through private equity investors via PIPEs.
Excerpt
UVA-F-1412
Rev. Jan. 6, 2011
Direct investment in the equity of distressed companies by private equity investors is a growing phenomenon dating to the mid-1990s. Prior to this, private equity investments in distressed firms (sometimes referred to as vulture capital) usually resulted from purchasing the debt instruments of failing companies or the assets of bankrupt companies. The growth in direct investment has been fueled by the number of publicly traded firms in need of additional funds. The premature public offerings of those firms, coupled with poor financial performance, has created greater demand for investments called PIPEs (private investment in public entities). The PIPE market has grown substantially in terms of funds raised—$ 1.3 billion in 1995 to $ 75.4 billion in 2008—and now rivals seasoned equity offers (SEOs) as an important vehicle for equity capital raising. Companies turn to PIPEs because their managers believe the financing provided by private equity investors will allow the company to first survive and then perhaps to prosper.
Private placement of equity has long existed as a means for companies to raise funds. In a traditional private placement, a block of shares was often offered at a discount to strategic investors who could aid the development of the firm. PIPE investments differ from these traditional private placements in several ways. First, the issuers typically are experiencing some form of distress that makes other forms of public-market financing difficult to obtain. Second, PIPE investors do not actively manage the troubled company to formulate a turnaround. Instead, they attempt to get out of their investments relatively quickly; they do not wish to be long-term or controlling shareholders in the firm. Third, compared with illiquid investments such as venture capital, PIPE investments have more immediate liquidity because they are made by firms with publicly traded equity. As such, it is an open question to what extent PIPEs can truly help a troubled company. One view is that they may just transfer the residual value of a troubled company from existing shareholders to new investors. Another view is that PIPEs provide much-needed funding, albeit at high cost, to firms that might otherwise fail without additional funds.
PIPE Market
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Keywords: bond valuation, capital raising, venture capital, private equity
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