Coming through the PIPE line


In the UK's increasingly crowded private equity mid-market, identifying new sources of deals is a kind of Holy Grail. But help may be at hand in the form of a consultation process that could pave the way for an increase in PIPE transactions (private investments in public entities).

The PIPE, a common feature of the private equity market in the US, has been rarely seen in the UK to date as a result of highly restrictive stock exchange rules, in particular in relation to pre-emption rights. These rights, which allow existing shareholders to be offered shares before they are offered to a new shareholder, can only be disapplied with the approval of 75 percent of shareholder votes cast at a general meeting.

In addition, the Investor Protection Committee (IPC), which represents major UK institutional shareholders, has advised its members to approve a resolution seeking the disapplication of pre-emption rights only in situations where it is restricted to the sale of 5 percent of the current issued share capital annually or 7.5 percent over a three-year period. While IPC guidelines do not constitute law, they are nonetheless influential.

PIPE deals are also complicated by an IPC ruling that companies should not make a non pre-emptive issue of shares at a discount to market price of five percent or greater.

Despite these obstacles to the would-be PIPE investor, the pendulum appears to be swinging just slightly back in their favor. According to the latest Private Equity Alert published by international law firm Weil, Gotshal & Manges, a consultation process is currently underway in which the London Stock Exchange is considering a proposal for fast growing companies in certain sectors (such as biotech) to allow issues of up to 25 percent of a company's share capital without pre-emption rights.

This ruling could provide the impetus for a type of deal that has clear benefits for both buyer and seller. For mid-cap public companies unable to secure adequate equity funding from existing shareholders, a new source of capital is opened up. For private equity firms hunting for deals in an over-fished pond, the opening of a new pipeline of investment opportunities would be greeted with glee.

US Fundraising surge in Q2
Private equity fundraising in the second quarter of 2005 was up markedly across the board, according to the National Venture Capital Association and Thomson Economics. The second quarter saw $22.1 billion raised for buyout and mezzanine funds, and $6.1 billion raised for venture capital funds. The quarter also represented the highest average commitment size since 2000. Thus far in 2005,96 venture capital funds have raised $11.8 billion and 76 buyout and mezzanine funds have raised $35.6 billion. In 2004, venture funds raised $17.5 billion and buyout and mezzanine funds raised $60 billion. In 2000, a high-water mark, venture funds in the US raised a whopping $106.6 billion, while buyout and mezzanine funds raised an impressive $76.8 billion.

NVCA pushes for federal funding law
The National Venture Capital Association is active in Washington, DC persuading lawmakers to expand on a rule that currently excludes venture-backed companies from a certain federal grant. A 2001 ruling from the Small Business Administration (SBA), which administers the program, found that startup companies majority owned by venture capital firms were not eligible for Small Business Innovation Research (SBIR) grants, which are intended to bolster the research efforts of small companies. At the time, the SBA argued that venture funds are often directly owned by large corporations, and therefore do not merit federal funds. In a recent press release, the NVCA says it is working with congress to make venture-owned companies eligible for the grants. The NVCA proposes a compromise on the issue that would ban large corporations from participating in the SBIR program. NVCA board member Dan Broderick, of the Mason Wells Biomedical Fund, recently testified before the House Small Business Subcommittee on Rural Enterprises, Agriculture and Technology Policy on the matter. According to the NVCA press release: ?[B]y imposing unnecessary restrictions against venture capital owned small business, the SBIR program is denying talented scientists the opportunity to develop new therapies and medical technologies at an early stage.?

SEC collects comments on small-company SOX rules
The Securities and Exchange Commission on Smaller Public Companies has collected public input on potential changes to the Sarbanes-Oxley Act of 2002 regarding smaller companies. The deadline for the input, organized as answers to a set of questions, is August 31. According to the SEC, the commission is seeking ?to improve the current regulatory system for smaller companies, and wants to hear from ?smaller companies and their managements about their experiences with the existing regulatory framework. The first question in the set is: ?Has SOX changed the thinking of smaller companies about becoming or remaining a public company? Many in the private equity industry have complained that SOX imposes a regulatory regime that is unfairly burdensome on small and middle market companies once they go public. On the other hand, many market participants report that the new regulations have increased deal flow as many public companies seek to go private with the help of private equity.