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A couple mulls a PIPE investmentWhen a company needs to raise capital, one of the ways it can do that is through a PIPE investment. This type of offering allows investors to purchase a certain number of restricted shares of stock from the company at a predetermined price. For companies, this can be a simpler way to raise capital compared to other options that may require more regulatory oversight from the Securities and Exchange Commission. PIPE investments can also create opportunities for investors if they choose to resell the shares they purchase. Whether you engage in a PIPE investment or not, a financial advisor can help you find the strategy and tactics that best fit your goals, timeline and risk profile.

PIPE Investment, Definition

The term “PIPE” is shorthand for private investment in public equity. When companies offer PIPE investments, what they’re really offering is the opportunity to buy shares in the company below current market value. Most often, these offerings are made available to institutional investors or accredited investors who have a higher net worth.

PIPE offerings can be attractive to companies as a means of raising capital since they’re subject to fewer regulatory requirements than more traditional public offerings. It may be possible to raise money for expansion, debt repayment or other financial needs in a relatively short period of time, without having to navigate an extensive maze of red tape to do so.

How Private Investment in Public Equity Offerings Work

Generally speaking, there are two sides to a PIPE investment. On one side is the company that’s offering shares for sale; on the other are institutional and accredited investors. With this type of offering, what’s one the table are restricted shares of the company. Restricted shares are ones that cannot be sold in the public marketplace unless the sale is considered to be exempt from SEC registration requirements.

Once a company decides to offer a private investment in public equity it can determine the price at which those shares are sold. Again, this price is set below the current market value to attract investors to the deal. The company then opens up the deal to investors who can purchase those shares, effectively at a discount.

This is how a traditional PIPE investment works. In a structured PIPE investment, the company issues convertible debt rather than discounted shares of restricted stock. In this instance, investors who buy the debt typically have the option to convert it to shares of company stock.

Why Companies Offer PIPE Deals

Businessman calculates how much capital he needs to raiseAgain, the primary reason companies may choose to offer private investment in public equity is to raise capital quickly. Companies may also seek this funding route if they’ve been unable to secure funding or financing elsewhere. For example, say you run a smaller company but you’d like to expand into a new market. You’ve tried to secure a business loan with no success. So you decide to offer a PIPE deal to attract new investors so you can get the capital you need to fund your company’s growth efforts.

Compared to something like a secondary offering, a PIPE investment is much easier for the company to compete. And this type of offering isn’t limited to certain types of companies. Any publicly traded company can offer this type of investment to institutional or accredited investors.

Pros and Cons of PIPE Investments

What’s good about private investment in public equity is also what’s problematic about it. In terms of benefits to the company, it’s all about gaining easier access to capital in the short term. And for investors who buy in, there’s the potential to resell those discounted shares for a substantial profit.

But there is a downside to this type of investment deal. PIPE investments can dilute the value of existing shares in the company. That may not be of much consequence to new investors buying in but it may be an unwelcome change among investors who already own shares in the company. If the investors who purchased discounted shares turn around and sell them within a relatively short time frame, this can push down the stock’s market price.

Another con has to do with who can take advantage of PIPE investments. Again, they’re limited to institutional investors and accredited investors. If you don’t meet the SEC’s definition of an accredited investor, based on your annual income or net worth, then this type of investment may not be an option for you at all.

Alternatives to PIPE Deals for Nonaccredited Investors

PIPE deals may only be offered exclusively to a small set of investors. If you’re not an accredited investor but you’re interested in private placement offerings, you might consider private equity exchange-traded funds instead.

Private equity ETFs allow you to own a collection of private equity investments in a single basket. This can include private equity firms that invest in PIPE deals. You get the advantage of liquidity since ETFs can be traded on an exchange just like a stock. ETFs can also be a tax-efficient way to invest inside a taxable brokerage account since they tend to have lower turnover compared to other types of mutual funds. And you may be able to reap some indirect benefits of PIPE deals, depending on what the ETF holds.

If you’re interested in private equity ETFs, opening an online brokerage account is the first step. When choosing an online brokerage first check to see if private ETFs are offered as an investment option. Then consider what you might pay in fees. Many brokerages have adopted a $0 commission model for stock and ETF trades though not all of them have.

Once your account is open, you can begin comparing private equity ETF options. As with any other ETF or mutual fund, consider the underlying holdings, expense ratio and overall performance when deciding among various investment options. It may be helpful to talk to a financial advisor as well to find the right ETFs for your needs and goals.

The Bottom Line

A retired man checks his investmentsPrivate investment in public equity, or PIPE investment, is an alternative to traditional stock trading that you might consider if you’re an accredited investor. While this strategy can be rewarding for some investors, it’s important to understand what it means for existing investors and the value of the shares they own. A PIPE investment can, for example, create opportunities for investors if they choose to resell the shares they bought.

Tips for Investing

  • Consider talking to a financial advisor about the advantages and disadvantages of PIPE investments. If you don’t have a financial advisor yet, finding one doesn’t have to be complicated. SmartAsset’s financial advisor matching tool makes it easy to connect with professional advisors in your local area. It takes just a few minutes to get your personalized recommendations online. If you’re ready, get started now.
  • Private equity ETFs aren’t all alike in terms of their objectives. Some can generate income, for instance, while others are more focused on matching the returns of a particular market index. When choosing this type or any other type of ETF, consider whether you lean more toward an active or passive investment strategy. This can determine which type of ETF is best suited for meeting your needs.

Photo credit: ©iStock.com/Ridofranz, ©iStock.com/SasinParaksa, ©iStock.com/FG Trade

Rebecca Lake Rebecca Lake is a retirement, investing and estate planning expert who has been writing about personal finance for a decade. Her expertise in the finance niche also extends to home buying, credit cards, banking and small business. She's worked directly with several major financial and insurance brands, including Citibank, Discover and AIG and her writing has appeared online at U.S. News and World Report, CreditCards.com and Investopedia. Rebecca is a graduate of the University of South Carolina and she also attended Charleston Southern University as a graduate student. Originally from central Virginia, she now lives on the North Carolina coast along with her two children.
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