You’re probably familiar with that age-old adage penned by Shakespeare: “A rose by any other name would smell as sweet.” Something similar can be said about private placement memorandums (PPMs), which are sometimes called offering memorandums or offering documents. Okay, so they don’t usually smell nearly as sweet as roses, but savvy business owners intent on offering private (rather than public) securities know that one of these documents—by whatever name it’s called—can be invaluable.
Others may be wondering just what is a private placement memorandum, or PPM? Many business owners are well-informed enough to take the steps necessary to establish a solid business plan in the early stages of company formation. They may be less familiar with the steps involved to create a PPM, however. For these entrepreneurs, a business attorney who is experienced in practicing securities law can offer a lot of bang for the buck by providing advice on the ins and outs associated with drafting a private placement memorandum.
What Exactly is a Private Placement Memorandum (PPM)?
As the name suggests, PPMs are specific to private, rather than public, transactions. This means the deals are not required to be registered with the U.S. Securities and Exchange Commission (SEC). At its core, a PPM is a document that can act as both a marketing document and a compliance tool. It resembles a business plan in some respects because it informs potential investors of the terms and risks related to investing in your business. However, the focus of a PPM rests more firmly with the legal issues surrounding that investment.
One of the biggest legal issues associated with a PPM is whether a company selling the securities (known as an “issuer” in SEC jargon) qualifies for one of the exemptions necessary to avoid SEC registration (which is time consuming and expensive) in the first place. Let’s just assume that a company has already established it qualifies for one of these exemptions and does want to put a PPM in place. This, again, is where one of those business lawyers well-versed in securities law comes into play.
Topics Covered in a PPM
PPMs are less “salesy” that business plans because business attorneys are usually the ones who draft PPMs. However, they still provide a wealth of information related to the business opportunity, company structure and management team. In fact, a PPM’s main purpose is to disclose all necessary information to prospective investors who are considering purchasing stock or some other security that the issuer is offering. Certain items that are found in most PPMs include:
- Introduction (sometimes in the form of an Executive Summary that lays out the offering and the opportunity in just a couple pages)
- Offering Terms Summary (including a description of the type of investor who may participate)
- Description of the Company (its industry, services and products, key customers, sales cycle, planned operations vs. current operations, etc.)
- Information about Company Management (biographies, including successful ventures and the unsuccessful ones, compensation to be paid to management, possible conflicts of interest)
- Use of Proceeds (in table format with detail)
- Description of Securities Offered
- Financial Information (historical and pro forma financial information – be sure to use “forward-looking statements disclaimer” language)
- Risk Factors
- Subscription Procedures
- Exhibits (including the Purchase/Subscription Agreement, Investor Questionnaire and company governing documents, such as the Certificate of Formation/Incorporation and Bylaws/Operating Agreement)
The SEC has industry guides that set out certain information required in SEC registration documents for the following industries:
- Electric and gas utilities
- Oil and gas properties
- Bank holding companies
- Real estate limited partnerships
- Property-casualty insurance underwriters
- Mining operations
The guides are available here – https://www.sec.gov/files/industryguides.pdf. While this information is required for SEC registrations, if you are offering securities in one of these industries, it is wise to disclose this same information to the extent it’s relevant.
The exact topics and the length and tone of them will all be determined by your specific offering.
Risk Factors in a PPM
The risk factors section is one of the most important sections in a private (confidential) offering memorandum. This is where you, the business owner, have a great opportunity to mitigate your risk by telling prospective investors the real deal regarding where things could go wrong. Some business owners are hesitant to be too frank. They worry investors will run the other way. While it’s possible to scare away an investor, that’s the point of the risk factors – to scare away anyone who doesn’t have the stomach or balance sheet to take the risk of investing. Seasoned investors, especially early-stage investors like angel investors and venture capitalists, know there is a lot of risk involved. Candid, specific risk factors won’t scare away sophisticated, seasoned investors. And, that’s the kind of money you want – intelligent, seasoned and not sweating every struggle of their portfolio companies.
Risk factors should be drafted in plain English as much as possible. The length and exact content of the risk factors should be tailored to your specific deal, which requires you and your advisors to carefully think through what are the right risk factors for this particular deal and how to explain them. NEVER SOFTEN THE TONE OF RISK FACTORS – A PPM SHOULD STRONGLY COMMUNICATE RISK.
If you are scared to say it straight and to tell an investor they may lose all their money, you shouldn’t be raising private capital. I can’t stress enough that the type of investors you want involved aren’t afraid of losing their money. They don’t want to lose their money, but explaining where things could go wrong doesn’t send them running for the hills. While you may want anyone’s check right now (before you have the money), I can relay plenty of stories of founders taking money from the wrong types of investors – unsophisticated, overbearing, unreasonable – and that’s a recipe for a very tough experience.
Group your risk factors into a few key categories. Typical categories are:
- Risks of the offering and the specific securities being sold
- Risks unique to the company
- Risks unique to the Industry
List them in order of priority under their appropriate category.
One last important piece of advice regarding creating the risk factors for your offering memorandum — Avoid generic, boilerplate risks. The SEC and state securities regulators want to see you took time to craft custom risk factors, specific to your company and the offering you are making to investors.
Do You Need a PPM When Selling Stock or Other Equity?
Now that you know the answer to the “what is a PPM” question, you can make a more educated decision on whether a private placement memorandum—AKA an offering memorandum or offering document—may be right for you and your business, whether your business is a startup or a more mature company.
The decision regarding whether you need a PPM is rarely straight forward. It depends on many factors, including how much money you are raising, who the target investors are (are they “accredited investors” or unaccredited? If the latter, you almost certainly need a PPM), how many investors will be involved, the industry in which you are operating (technology companies rarely use them, especially in startup markets like Austin, Texas, which have robust, sophisticated startup communities, however for restaurant and real estate offerings we almost always prepare PPMs and investors expect them), your budget and your personal appetite for risk.
I always tell entrepreneurs and business owners that securities law is one area where we need to be very conservative – there is a lot of personal risk, including possible criminal exposure. That said, it’s not always the right decision to draft a PPM just out of fear. Together, we can make a more informed, intelligent decision.
For more information about whether you need a PPM when raising capital for your startup, read Do I Need a Private Placement Memorandum (PPM) to Raise Startup Money?
With all that said, I can’t stress enough just how nuanced and complex securities law can be. For that reason, you may want to consult with an attorney experienced in practicing this type of law to make sure you can draft your PPM in a way that will keep your proverbial rose smelling every bit as sweet as Shakespeare’s literary roses.
If you are raising money for your startup or other business and want to talk about securities law, PPMs or anything else, please get in touch. I have offices in Austin and Houston, Texas, although, depending on what you’re doing, I may be able to help you out no matter where you are in the world.
Author: Brett Cenkus
Brett Cenkus is a business attorney with 18+ years experience based in Austin, Texas. He has worked with a variety of businesses and has clients throughout Texas as well as many technology clients throughout the United States. Brett is a Harvard Law graduate with a sharply seasoned mind and an entrepreneurial heart. As a founder of 6 companies himself, he is especially passionate about helping startups succeed. In 2016 Brett was named the winner in the Individual category for RecognizeGood’s Ethics in Business & Community Award. He offers businesses solutions that are in sync with their culture, goals and values. You can learn more about Brett by visiting the About page on this website.