Obvious in hindsight: On financings, pricing uncertainty, and early access to data
by Peter Kolchinsky and Sarah Reed
Peter Kolchinsky is founder and Managing Partner and Sarah Reed is General Counsel at RA Capital Management.
April 15, 2024
Companies are free to confidentially share data or other non-public information with investors of their choosing and complete a financing (such as a private investment in public equity, aka a PIPE) with those investors before publicly disclosing the data or other information, even the fact that the company is raising money in the first place. How is this fair? Shouldn’t there be a level playing field where no one has privileged access to information that informs the decision of those investing in a financing?
Here’s the bottom line: Sharing confidential information in the context of a financing is allowed and common and providing an early look at data is logical in certain circumstances — especially when data are unclear — giving companies more options for attracting capital at terms they find acceptable. Let's break it down below.
Allowed when there’s information symmetry
There is no prohibition against buying stock while in possession of confidential company information if the counterparty – in this case, the company selling shares in a PIPE – possesses that same confidential information. The point is that there has to be information symmetry between the parties trading shares. The company can choose who it wants to bring over the wall and has no obligation to bring all investors in the world over the wall on any financing.
Sharing confidential info is necessarily common
Consider that any financing that involves bringing investors over the wall involves non-public information (i.e., the fact that the company is doing the financing is itself non-public information). Other investors not brought over the wall don’t get the benefit of that knowledge while the transaction is happening and don’t get the price that winds up being negotiated between the company and the wall-crossed investors. But it’s allowed because the transaction is between the company and participating investors, who both are aware of the financing and, in some cases, data the company has not yet made public.
Sharing confidential data can be logical in the face of uncertainty
Why might companies share confidential data in the context of a PIPE instead of disclosing it and then raising? Stocks don’t always go up on what might seem to some to be fundamentally positive news, which is a risk for a company that is low on cash and needs to raise.* And even if they go up, they may not stay up. And when a stock climbs on data, those may be prices at which some people are willing to trade but not prices at which institutional investors will make large, often illiquid investments. This represents financing uncertainty or at least pricing uncertainty for companies, and helps explain why companies that need cash may elect to share with investors the risk that the stock might not go up once the news is disclosed, or at least might not support a financing at a higher price.
When a company does a PIPE with confidential data disclosure to select investors and then the stock climbs once the data and financing are disclosed, it may seem like the company should have released the data first and then financed at a higher price. But would the stock have gone up without the financing?
Maybe it’s the combination of 1) data release and 2) news of the financing (which shows other investors, many of whom likely borrow conviction, that some specialists believe in the company and think the data should be viewed as good news) that results in the stock going up – even though it might have gone down on the data release if there hadn’t been a concomitant financing.
We don’t have the counterfactuals to know for sure in any particular case, but when some investors choose to pass on a PIPE after seeing the confidential data, that suggests that there is some disagreement about whether the stock will go up once the news and financing is disclosed. Some PIPE financings don’t even get done after investors are wall-crossed. So to suggest that companies that do these PIPEs with confidential data disclosures are depriving other investors of a fair shot at easy gains is to assume a level of certainty about how well the news would have been received by the broader market and how much the news fundamentally de-risks the company.
Plenty of companies elect to disclose their data and then raise; those are more likely to be cases where there is greater certainty that the data are so good that their release would cause investors to bid up the stock or else greater certainty that the data are so bad that no investor would want to participate in a financing until seeing how low the stock has dropped. So it’s in the cases of uncertainty that a company is likely to try for a PIPE or other financing with confidential disclosure of data.
At the company’s discretion
Should all PIPEs be disallowed? It would be a big change in securities regulations to prohibit public companies from accessing capital through these transactions, which are speedy, efficient, and less costly, often obviating the need for underwriters (and their large fees), even with some disadvantages for investors. **
Should sharing of confidential data be disallowed? It would force companies to take on greater pricing uncertainty than they sometimes prefer. That’s one less tool in a company’s toolkit.
There are times when investors won’t invest unless they see the data they know the company has, so if the company won’t have the option of sharing the data confidentially, it will be forced to disclose it. But the conditions following even a positive disclosure may then make it difficult to do a financing; it’s not uncommon for the animal spirits of the market to cause a stock to trade up sharply, reflecting prices that traders are willing to trade at but above prices at which institutional investors are willing to build large, illiquid holdings. The company will likely be able to finance but might need to come to terms with giving investors a deep discount, especially in the case of a PIPE whose shares won’t register for several months, obliging participants to hold long past the time when animal spirits are likely to have cooled. This isn’t uncommon and isn’t clearly better for the company and non-participating shareholders than if the company had raised prior to the data disclosure with confidential data disclosed to investors.
Ultimately, it’s not investors who choose what kind of financing a company does. Companies do.*** They assess their options and in certain cases elect to do a PIPE, sometimes confidentially sharing data with investors before it’s publicly disclosed. So why would companies do this if it were only in the interest of participating investors? They wouldn’t. Management teams don’t want to be unnecessarily diluted and have a fiduciary duty that directs them to not just hand out value to anyone who asks (even in the cases of participating investors also serving on the board of the company, odds are that all the other directors approved the transaction). So if they choose to share data in the context of a PIPE, it’s because they have considered alternatives and, in their judgment, think this is the best course of action for all shareholders given all the uncertainties.
*Among companies completing PIPEs in the past three years, Surrozen and Solid Biosciences traded below their deal prices one day after their financings were disclosed, and Lexeo Therapeutics, Cybin, and Harpoon Therapeutics broke their deal prices within a week. Some of these involved confidential disclosure of data to investors prior to the financing being announced.
**PIPE shares are not registered immediately and therefore cannot be sold until they are, often months later. Should a stock surge following a PIPE announcement, non-PIPE shareholders have an opportunity to sell their shares at the elevated price but locked-up PIPE participants can’t until their shares are registered. So PIPE participants must look far ahead and base their decision on how the stock will be valued long after the animal spirits surrounding data disclosure have settled. Investors factor this illiquidity into the terms of the financing.
***Under some circumstances (e.g., the company has insufficient shares of common stock authorized for issuance) a PIPE is the only kind of financing a company can do.
Please click here for important RA Capital disclosures.
