Funding Indian Companies with PIPEs
By
William Cate

In 2003, private equity investments in India totaled over one billion U. S. Dollars. Over eighty investors risked their money in over ninety Indian companies. However, private investment worldwide has been on the decline for the past three years. It's expected to continue to decline and Indian companies shouldn't expect to be exempt from this trend. The increasingly popular alternative to traditional investment options is Private Investment in Public Equities (PIPEs).

During the 1990s, American Venture Capitalists financed about one private company out of every two thousand five hundred reviewed-business plans. After the one trillion-dollar Dot Com Meltdown, the odds of a private company receiving money from a Venture Capitalist declined to less than one financing in every ten thousand reviewed-business plans. The American Venture Capitalist's initial investment package has declined from fifty million dollars to less than one million dollars.

The mutual fund industry mushroomed through the boom of the '90s and mutual funds became a staple for US (and increasingly international) investors. Currently, they hold seven trillion dollars in assets from some ninety one million American public investors. In the past two years, a series of scandals have plagued the industry. Last year, four hundred and sixty four Mutual Funds were liquidated. Eight hundred and seventy firms were merged into larger and stronger companies. And, there were about fifty percent fewer new Mutual Funds formed. The creation of American Mutual Funds for overseas investment has declined and may eventually disappear.

Hedge Funds manage about six hundred billion dollars. Because their investors are wealthy Americans, they have not been subject to rigorous U.S. Securities and Exchange Commission regulation. Recent Hedge Fund Scandals have created political pressure for Hedge Fund accountability. The regulatory inclination will probably limit the scope of Hedge Fund investment and operation in the future.

Access to these three traditional sources of business risk capital is likely to continue to contract. Their investment strategies are riskier than PIPEs. And, it's the loss of investor capital that creates the scandals. It's the scandals that motivate regulatory investigations. And it's the investigations that create the media problems and the risk of civil or criminal charges. For fund managers, it's safer and more profitable to reduce risk.

The American investment community is moving toward PIPEs. That is Private Investment in Public Equities (PIPE). They offer the investor liquidity, which reduces risk. PIPEs offer investors and the company greater leverage potential, which increases potentially greater profits.

Investment in a private company is difficult to recover. The company must be sold or the investors must wait until the private company's profits repay the risk capital. In a public company, subject to regulatory requirements, investors can quickly sell their shares and hopefully recover their risk capital and even make a profit on a bad investment. Public company stock is a guarantee against complete loss of a risk capital investment. As in Venture Capital Models, the investors need not assume a percentage of loses in their profit calculations.

The Market Capitalization (issued shares multiplied by the company's share price) is usually a multiple of the balance sheet value of most public companies. The greater value of the shares means that the investor leverages his investment by taking stock for his money. Equally, the public company can leverage its balance sheet by using its shares to acquire cash-producing assets and building the company. The axiom is the West in that Stock is Money.

Merchant banks are the traditional source of PIPE financing. However, in the past three years, major Venture Capitalists and Mutual Funds have entered the PIPE Market. Currently, there is more money available for PIPE financing than sound potential investments in U.S. Public companies. U.S. regulatory policy makes PIPE investing outside the United States more attractive, less risky and more profitable than doing PIPE financings of U.S. Domestic companies.

Non-U.S. Public Companies aren't held to the same disclosure standards as their U.S. Domestic counterparts. The lower U.S. Securities and Exchange Commission reporting standards for non-U.S. public companies potentially makes investing in these companies less risky and more profitable. However, the investor is betting that the company is honestly managed and a scandal isn't likely.

There are two basic types of PIPEs. A Traditional Pipe is the sale of unregistered shares, usually common stock, preferred shares or convertible securities at a discount to the prevailing market price of the stock. A Structured PIPE is the sale of unregistered stock at an adjustable share price; the primary risk in doing a Structured PIPE is that it can create a toxic convertible. The PIPE investor can use his PIPE shares to sell short the company's stock. As the Company's share price falls, the investor has the right to more company shares. These shares are used to sell short more shares of the company's stock. As the short selling process continues, the company's stock goes into a death spiral.

Startup companies, R&D projects and debt consolidation aren't easily sold to an investor as a PIPE financing. Growth capital that allows the company to increase sales and acquisition financing are the wisest proposed use of funds when your company wants a PIPE underwriting.

Private Western Investors are unlikely to be active in management buyouts in India because of possible regulatory hitches. India has a huge market for Mergers and Acquisitions. There are numerous assets in many companies that should be accumulated by farsighted Indian companies. In India, there's massive potential for consolidation and corporate growth. It's an opportunity that would interest many Western money managers.

American PIPEs are a unique investment vehicle. They provide public companies with a quick channel to capital. The process to complete the deal is much faster than a traditional secondary offering. It isn't that difficult or expensive to become an American public company.

Any public company in India can easily determine Indian Venture Capital and Mutual Fund investment interest in doing PIPE underwriting for their company. If the public company wants to access western capital, the public company's shares should trade in the United States. There are two cost-effective strategies that that will allow their shares to trade in the States.
1. The Indian Company can have their shares trade as ADRs (American Depository Receipts). The primary U.S. Bank creating ADRs is the Bank of New York.
2. The Indian Company can list their shares on any U.S. Stock Market.

A private Indian company should determine both the costs of going
public in India and the availability of Indian PIPE underwriting for their company, if they take their company public. The private company's alternative would be to take their company public in the U.S.

In the United States, the more credible the Stock Market, the greater the costs of listing your shares on it. There are far more PIPE investors for a New York Stock Exchange Company than one that trades on the Over-the-Counter Market. PIPE investors funding New York Stock Exchange Companies are willing to risk far more money than those working with Over-the-Counter public companies. So the more money your company wants to raise in a PIPE financing, the greater the costs of listing your shares in the United States.

What does it cost to list your company in America? A rough estimate for the New York Stock Exchange would be five million U.S. Dollars. For Nasdaq, the American Stock Exchange or a Regional Stock Exchange, a rough estimate would be two million U.S. Dollars. For the Over-the-Counter Market, the costs should be less than one hundred thousand U.S. Dollars.

The listing problem related to costs is the time it takes to list your company in the United States. A New York Stock Exchange listing can take several years. Listing on Nasdaq, the American Stock Exchange, or a Regional Stock Exchange would take about eighteen months. To list your shares on the Over-the-Counter Market should take less than six months.

Business relationships are built over time. Unless your company is among the economic powerhouses of India, you are better served starting small and building relationships with Western investors. Develop a business plan that will grow your company into a regional powerhouse and use PIPEs to add to your balance sheet assets.

About William Cate: In 1981, he founded and has since been the Managing Director of Beowulf Investments: [http://home.earthlink.net/~beowulfinvestments/ ]. He is the author of Venture Capital Profits, which proposes the use of PIPEs to build companies through a process of Mergers and Acquisitions.

Author's Note: This article appears in early 2004 in an Indian newspaper.


About the Author
He has been the Managing Director of Beowulf Investments [http://home.earthlink.net/~beowulfinvestments/] since 1981 and is the Executive Director of the Global Village Investment Club [http://home.earthlink.net/~beowulfinvestments/globalvillageinvestmentclubwelcome/]