Equity Instrument Features

Publicly Listed versus Private Equity Securities

The vast majority of corporations in any developed economy are privately held. In the United States, for instance, private firms outnumber publicly traded firms by approximately 1,000 to 1, with publicly listed companies representing only about 0.1% of all corporations. Despite this numerical disparity, the total market value of publicly listed equity is roughly 10 times that of the global private equity market.

Publicly listed equity has the following features:

• Trades on organised exchanges such as the NYSE or NASDAQ.
• Is generally liquid, with readily observable prices and the ability to execute trades quickly.
• Requires companies to meet exchange listing requirements (minimum market capitalisation, number of shareholders, etc.) and adhere to ongoing disclosure obligations, including periodic audited financial statements.
• Has seen a significant decline in the number of listed companies in the US, over 50% from its peak in the late 1990s, owing to factors such as increased regulatory burdens, higher compliance costs, and the expansion of private capital.

Private equity encompasses a broad range of investment strategies across the company life cycle:

• Venture capital – Invests in early-stage start-ups with high failure risk but substantial upside potential.
• Growth equity – Targets profitable but rapidly expanding companies that need additional capital.
• Buyout funds – Acquire mature companies, often using significant debt financing in a leveraged buyout (LBO). In a take-private transaction, investors purchase all outstanding common shares of a public company, delist the shares, and take full control. If the acquiring group includes existing management, it is called a management buyout (MBO). The objective is to restructure the acquired firm, improve operational efficiency, and later exit by selling to another buyer or through a new IPO. A well-known example involves a centuries-old family-owned footwear company that sold a majority stake to a private equity firm and then returned to public markets via an IPO several years later.
• Special situations – include distressed investments and PIPE (private investment in public equity) transactions.

A PIPE transaction occurs when a publicly traded company raises capital quickly by selling a block of shares to a small group of private investors, usually at a discount to the current market price. This dilutes existing shareholders. For example, a company with 20 million shares outstanding, trading at USD 8 per share, might sell 2 million new shares in a PIPE at USD 7 per share. The total value after the transaction becomes USD 174 million, divided among 22 million shares, resulting in a diluted price of approximately USD 7.91 per share.

Question 1

A publicly traded company has 10 million common shares outstanding, trading at USD 50 per share. It urgently needs to raise capital and complete a PIPE transaction, selling 1 million newly issued shares to a group of private investors at USD 40 per share.

After the transaction, the company’s share price will most likely be closest to:

1. 1. USD 40.00
   2. USD 49.09
   3. USD 50.00

Solution

The correct answer is B.

The pre-transaction equity value is \(\text{USD } 50 \times 10,000,000 = \text{USD } 500 \text{ million}.\) The proceeds from the PIPE are \(\text{USD } 40 \times 1,000,000 = \text{USD } 40 \text{ million}.\) Total equity value after the transaction is \(\text{USD } 540 \text{ million}.\) Total shares outstanding after the transaction are 11 million. The diluted price per share is \(\text{USD } 540 \text{ million} \div 11,000,000 = \text{USD } 49.0909,\) or approximately \(\text{USD } 49.09\). The discounted issuance dilutes existing shareholders, reducing the share price from \(\text{USD } 50\).

A is incorrect. \(\text{USD } 40.00\) is the price at which the new shares were sold to private investors, but it does not reflect the post-transaction market price. The existing shares do not drop all the way to the PIPE price because the company received new capital, which adds value. The price after a PIPE is a weighted average of the prior market price and the PIPE price, not simply the lower of the two.

C is incorrect. \(\text{USD } 50.00\) is the pre-transaction market price. The issuance of new shares at a discount dilutes existing shareholders, so the price cannot remain unchanged. The transaction transfers value from existing shareholders to the new investors, resulting in a lower post-transaction share price.