Investor rights and company protections tend to be the most extensively negotiated aspects of a PIPE transaction. While they can vary considerably from deal to deal, we summarize certain common rights and protections we see when negotiating PIPE transactions below.
For private equity investors, an important aspect of investing involves securing strategic oversight of portfolio companies. PIPEs generally do not provide an investor with the same degree of control over the company as would be typical in a pure private equity buy-out transaction. While an investor may gain some influence over corporate decisions, public companies may resist granting the investor approval rights over key business decisions or fundamental changes to the organization; there are few examples where approval rights have been given. As a result, there may be an underlying tension between traditional private equity and PIPEs, depending on an investor’s typical investments and strategy.
Investor rights
Investors may request certain types of rights to safeguard and monitor their investment.
Registration rights
The investor may have the right to require the company to file a prospectus to qualify the securities issued under the private placement for resale, typically pursuant to a registration and qualification rights agreement (registration rights). Registration rights may include, or be limited to, “piggyback” rights to participate in an offering being conducted by the company, but without the ability to “demand” a registration. Principal areas of negotiation will include
- the threshold at which the registration rights fall away
- the number of times that registration rights may be exercised
- postponement rights for the company in certain circumstances
- who bears the costs associated with any registration or qualification
- indemnification obligations
Information and inspection rights
The investor may have the right to receive certain information over and above regular public company disclosure required to be made to shareholders. Information rights may include the right to review monthly financial statements and to be provided advance notice of certain transactions. Similarly, the investor may have the right to conduct inspections of the company’s records. These rights are typically subject to confidentiality obligations as well as restrictions on the use of information.
Anti-dilution protection and pre-emptive rights
Convertible securities may include anti-dilution provisions that automatically adjust the conversion price or increase the number of shares an investor receives under certain circumstances, such as
- a consolidation of the outstanding common equity
- a share dividend or other distributions of common equity to existing shareholders
- a payment of an extraordinary cash dividend
- the issuance of convertible securities with unequal conversion terms.
These provisions, commonly structured on a “weighted-average” or, less frequently, a “full-ratchet”, basis, are intended to preserve the investor’s economic position and must be carefully drafted to comply with TSX and TSX-V rules on pricing and shareholder approval.
Investors may also negotiate for pre-emptive rights. Pre-emptive rights are a preferential right to
- provide future financing
- acquire a proportionate share of any securities issued as part of future financings
- maintain an investor’s proportionate equity interest in the company
These rights are usually exercisable within a specified notice period and at the same price and terms offered to other investors.
Anti-dilution protections and pre-emptive rights may be subject to limitations to avoid unduly constraining future capital raising flexibility; for example, a company may not have to comply if
- any actions taken in connection with this right would require seeking shareholder approval
- the investor’s ownership falls below certain thresholds
- the securities are issued under employee plans or as consideration for strategic acquisitions
Board nomination rights
Board nomination rights provide the investor the right to require the company to nominate one or more directors to the board of the company. Nomination rights are often proportionate to the investor’s interest, and may terminate if the investor disposes of a certain percentage of securities it acquired from the company pursuant to the PIPE transaction or if the investor’s ownership in the company drops below a certain threshold. Nomination rights may include the right for the board nominee to sit on all, or a subset of, board committees. Where nomination rights are unavailable, an investor may instead negotiate for the right to appoint an observer to the board and its committees. When negotiating director nomination rights, investors should keep in mind that all directors, including nominee directors, will be subject to shareholder approval and owe fiduciary duties to the company (and not to the investor specifically).
Investor redemption rights (put rights)
Investor redemption rights are the right of the investor to require the company to repurchase the investor’s securities typically at a pre-determined price, such as a floor return, in certain circumstances, including if the company sells all or substantially all of its assets, becomes de-listed from the stock exchange on which its securities are listed or engages in a fundamental change (including a change of control). Investor redemption rights may be mandatory (i.e., the triggering event results in an automatic redemption with no election by the investor or the company required and no option for partial redemption) or at the option of the investor (i.e., the investor may elect for the company to redeem all or part of its securities). Contractual redemption rights are challenging in light of the securities law requirements for issuer bids, though redemption or retraction rights may be included in the terms of a particular class of securities.
Approval or veto rights
The investor may have the right to approve or veto significant actions or important decisions of the company regarding its business, including
- fundamental changes, such as amending the company’s articles and/or bylaws
- issuing new classes of securities ranking in priority to the class of security issued as part of the PIPE transaction
- incurring additional indebtedness in excess of prescribed thresholds
- payment of dividends by the company
- making substantive changes to the company’s business plan or operations
Ancillary business rights
The investor may negotiate for additional rights to safeguard its strategic interests, such as a right of first refusal on the sale of identified assets, a right to appoint members to a technical or advisory committees or a right to enter into future collaboration or commercial agreements.
Company protections
Companies may also require certain protections in connection with a PIPE.
Transfer/resale restrictions
A company may negotiate for a mandatory post-closing hold period that is beyond the four-month statutory period (typically varying from one to three years) or other restrictions on the investor’s ability to transfer its securities. These restrictions provide the company with greater certainty that the investor will remain aligned with the company and its strategy over a longer period. Other restrictions that may be negotiated include limitations on how resales may be made (e.g., restricting resales to broadly marketed distributions or prohibiting resales to customers, competitors or other significant shareholders of the company). Alternatively, a company may seek an opportunity to “place” the securities in the hands of a supportive shareholder before the investor is able to sell them.
Standstill
A company may be able to negotiate an investor standstill for either a fixed period of time or for so long as the investor owns a minimum percentage of the company’s securities. During the standstill, the investor agrees not to acquire any additional securities of the company or to engage in actions that the company’s board of directors considers hostile, which may include proxy contests that involve replacing the directors and unsolicited take-over bids.
Company redemption (call rights)
A company may be able to negotiate the right to force a repurchase or redemption of the investor’s securities in certain circumstances, such as the expiration of a lock-up period, the attainment of a predetermined share price or the passage of a defined period of time. Investors may try to mitigate against company-forced redemptions with redemption premium payments. In the context of convertible securities, redemption rights may allow the company to redeem the securities prior to conversion, thereby managing or limiting potential dilution to existing shareholders.
Voting support
A company may seek a commitment from the investor to vote as directed by the company for a fixed period of time. The scope of these voting support arrangements can vary, but may include agreements to support board-nominated director candidates or to vote in line with the board’s recommendations on certain corporate matters. If the investor agrees, these provisions typically exclude special business, such as a potential sale transaction.
Conclusion
PIPE transactions offer many benefits to investors and companies alike, providing a mechanism for public companies to access private capital pools and for investors to deploy capital relatively quickly into public markets on flexible terms. Given the bespoke nature of these transactions, financial and legal advice is critical to help the parties navigate these deal dynamics effectively.
