Why do you need a Private Placement Memorandum?
A private placement memorandum, also known as a PPM, is the legal disclosure document used by businesses to raise money.
A Private Placement Memorandum is the legal document that is given to prospective investors when selling stock in a business, which is by law considered a security. A Private Placement Memorandum may also be referred to as an offering memorandum or an offering document. A Private Placement Memorandum is used in “private” transactions. This means that the the securities are not registered under federal or state law. Instead, the securities are sold pursuant to an exemption from registration. The Private Placement Memorandum’s main purpose is to disclose the risks involved in the investment.
What is the difference between a Business Plan and a Private Placement Memorandum?
A business plan and a Private Placement Memorandum are different. A business plan is a marketing document. The business plan is used to promote interest in the business. The business plan describes the favorable market demand, customer profiles, growth opportunities, competitive landscape, revenue channels, and potential strategic partners. A Private Placement Memorandum on the other hand is a legal disclosure document. It is not as persuasive as a business plan. Instead, it is more objective and factual. It discloses the risks facing the business. Nonetheless, so long as the Private Placement Memorandum is presented in a professional manner, it will still serve the purpose of selling the business. It will let the potential investors know that you are a professional business person and you are disclosing all material challenges involved in the business so an informed decision is made. This protects you from any potential allegations of misrepresentation in the future. The purpose of the Private Placement Memorandum is to protect you from any allegations of securities fraud in the future.
What is a Private Placement Memorandum?
The Private Placement Memorandum is a very thorough legal document. The purpose of the private placement memorandum is to allow the investor to make an informed decision. All security transactions must comply with the anti-fraud rules of the federal securities laws. There can be no false or misleading statements about the business or the investment. The investor must be fully informed about the business, the management, the financial status, and all risks. It is important to have the assistance of an experienced attorney because there are many consequences that may occur if full disclosure is not made, such as civil liability and even criminal liability.
What is included in a Private Placement Memorandum?
An Introduction about the Business
The business deal should be thoroughly described in the first pages of the Private Placement Memorandum. This includes the basic terms of the offering, a company overview, the business purpose, and all “legends” required by federal and state laws. When raising capital in the U.S., you must specify the individual states in which you are approaching investors. You are required to provide specific federal and state disclosures in the Private Placement Memorandum. Also, if you are raising capital from overseas investors, it is highly recommended to include the proper disclosures for those specific countries.
Management of the Company
The company’s background information must be provided to any potential investor. The type of products and services that the business provides must be fully described. Past performance history, the industry, goals, market competition, advertising and marketing strategy, suppliers, intellectual property portfolio of the business, customer descriptions, and any other material information that would be relevant to the investor must be disclosed. The biographies of the management team, including any of their special skills, education, training, and any other background information must be provided. Essentially, the investor is placing the success of the investment in the hands of those responsible with managing the business.
Current Capitalization of the Business
The capital structure of the company, before and after the offering, must be disclosed. All authorized and outstanding securities must be disclosed, including any long-term debt and liabilities incurred by the company. Financial Statements must be provided to potential investors. The type of statements that the issuer has to provide will vary according to the amount of money to be raised, applicable federal and state regulations, and the company’s nature and stage of growth. The Private Placement Memorandum must disclose the company’s current and projected financial condition.
Terms of the Offer and Description of the Securities
This section includes the process for raising capital for the business. The number of shares that will be issued and the price of those shares must be disclosed to the potential investor. Other terms may include process for liquidation, conversion rights, anti-dilution provisions, voting rights, pre-emptive rights, total authorized stock, different classes of shares or restrictions on declaration and distribution of dividends, any relevant limitations or restrictions as stated in the company’s articles of incorporation or bylaws, and any other material terms that the investor should know to make an informed decision about the business deal. Essentially, this section describes the rights, restrictions, and class of securities being offered. For instance, the investor must know if they will have voting power in making any decisions that materially impact the business. The company must also disclose its ability to change its capitalization, such as issuing different classes of shares and whether it intends to distribute dividends.
This section discusses the number of shares outstanding prior to the offering. There must be disclosure of the price paid, the net book value and the effect of the proposed offering on existing shareholders, as well as its diluting effects on new purchasers’ shares at the completion of the offering. Disclosure must be made if the founding shareholders, advisors, or promoters of the offering have acquired their securities at prices substantially below the prospective offering.
This section includes a disclosure of the risks common to similar investments and any specific risks that are unique to the particular business. These risks may be that the business is dependent on a strategic partnership or that the business is in a highly competitive industry.
Use of Proceeds
The company must describe how it will use the net proceeds raised in connection with the offering. The Private Placement Memorandum should also itemize the approximate amount for each intended purpose. This will disclose to the investor how their money will be used. This is very important because any material deviation from the use of these investor funds as disclosed in the Private Placement Memorandum could trigger liability on the company and its management.
This section describes the instructions and procedure for investing in the offering. The investor must “subscribe” to purchase the securities. The subscription materials must be provided to the investor.
When the prospective investors decide to provide capital to the company in accordance with the terms of the Private Placement Memorandum, legal documents must be signed. These include an Investor Questionnaire and the Subscription Agreement.
The Questionnaire is used to obtain certain information from prospective investors. The Questionnaire serves as evidence of the investors necessary level of sophistication, experience, and intelligence in order to make the particular investment. The Questionnaire requests the prospective purchaser’s background, citizenship, education, employment, investment and/or business experience.
The Subscription Agreement is the contract between the investor-purchaser and the issuer-seller for the securities. It contains acknowledgments of the purchaser’s receipt and review of the information in the Private Placement Memorandum. This includes any restrictions on the securities, that the securities were acquired under an exemption from registration; any investor requirements such as the amount of investment or passive income, or tax bracket, which the issuer feels may be crucial; an acknowledgement of the specific risks disclosed in the Private Placement Memorandum. The Subscription Agreement also contain the purchaser’s reconfirmation of the information in the Questionnaire, the number and price of the securities to be purchased, the manner of payment, and an agreement to any special elections that may be contemplated such as “S” corporation elections, accounting methods and any relevant tax elections. The Subscription Agreement often contains an agreement on the part of the purchaser to indemnify the issuer against losses or liabilities resulting from any misrepresentations by the prospective purchaser that would void or destroy the exemption from registration.
All documents that may be material to the investor’s investment decision must be provided. These exhibits may include copies of investment contracts, financial statements, the organizational documents of the issuer such as articles of incorporation or bylaws, key contracts, licenses, intellectual property registrations, property leases, press releases, brochures, news articles, marketing reports, and resumes and CVs of management. These documents will be reviewed by the investor’s attorneys and accountants during its due diligence process in making its decision to invest in the business. Any material information or documents not disclosed can result in civil or criminal liability on the part of the business owners seeking to raise the capital. This is why it is very important to work with an experienced business attorney