What is a Private Placement Memorandum (PPM)?
A private placement memorandum may also be called an offering memorandum (OM), confidential offering memorandum (COM) or confidential information memorandum (CIM). A PPM is similar to a business plan, although it focuses much more on legal issues. The primary purpose of a PPM is to disclose to prospective investors the terms of a potential investment and primary risk factors involved in making the investment. A PPM also usually contains a considerable amount of information about the business opportunity, structure and management. It is less sales-oriented than a traditional business plan, partly because business lawyers typically create them.
As the name implies, a private placement memorandum is private and does not pertain to public transactions. In other words, PPMs deal with transaction that are not registered with the U.S. Securities and Exchange Commission (SEC).
From the standpoint of a company raising money (called an “issuer” in SEC terminology), a PPM is a safety belt offering protection to a company selling unregistered, private securities. The securities may be stock or other equity interests (e.g., limited liability company membership interests) or they may be some type of debt instrument. Most people don’t think of loans as securities, although they can be, depending on how they are structured. When I use the word, “unregistered,” I am referring to securities that are not registered with the SEC. Publicly-traded companies register their securities with the SEC through a laborious review process.
PPMs provide investors a thorough company description, the company’s financials, the terms of the offering and the associated risks. Depending on who is drafting the PPM, it may contain other sections and topics. For transactions involving public offering or securities of a publicly-traded entity, a prospectus would be used instead of a PPM.
So, the key takeaway here is that PPMs are about disclosure, but in private transactions.
Are PPMs Required When Raising Private Startup Capital?
Some founders and startup entrepreneurs believe that a PPM is needed any time capital is raised or securities are issued in a private offering, including early-stage financing, Series A, Series B financing rounds or so on.
However, that is not technically true.
Whenever you issue securities, you must register them with the SEC or find an exemption for doing so. Most private offerings are done pursuant to Rule 506(b) of Regulation D of the Securities Act of 1933, which is a special type of “safe harbor” exemption. If you comply with the terms of Regulation D of Rule 506(b), you can rest confidently knowing that your transaction is considered a private transaction. This is important because if it were deemed to be a public transaction, you would have to go through the expensive process of registering the securities with the SEC (and possibly state securities boards) before selling them. That is time consuming and expensive process.
Don’t be fooled by the term “public offering.” It doesn’t mean only the big initial public offerings (IPOs) that you hear about in the Wall Street Journal. It can be mean any offering where the number of offerees or investors or the type of solicitation (i.e., how wide a net you cast when looking for investors) is such that the SEC would consider the transaction to be a public offering of securities. In a private offering under Rule 506(b) where you raise money from accredited investors, you don’t have an obligation to deliver any specific information to the prospective investors, provided you don’t violate the antifraud rules. Rule 506(b) allows companies to raise money from unaccredited investors, although you’d then be required to provide certain information, which is similar in scope and form as the information required in registered offerings with the SEC.
The SEC website defines an accredited investor as an individual who (a) has earned more than $200,000 ($300,000 with their spouse) in each of the prior two years with a reasonable expectation of earning at least that in the current year; or (b) has a net worth over $1 million, either alone or together with a spouse (excluding the value of the person’s primary residence and any loans secured by the residence (up to the value of the residence)). There are other meanings of accredited investors that apply in the case of entities (corporations and LLCs, as opposed to individuals).
The takeaway here is that if you use the 506(b) safe harbor (which is a great exemption to use, by the way – easy and SAFE) and only offer securities to accredited investors, you do not technically have to provide the disclosures contained in a PPM (for clarity, the disclosures and information in a PPM are much less than in a registered offering).
Do Business Lawyers Advise Preparing a PPM Whenever Raising Startup Capital?
Corporate lawyers know that entrepreneurs and startup founders don’t need a PPM for every capital raise.
In a small deal, (raising less than $100,000 for example), it may be difficult for the founders to justify the cost of the PPM. Keep in mind, though, that whether you create a PPM has more to do with the overall risk profile of how you are raising money for your startup than how much capital you raise. The further removed the investors are from your existing personal network, the more you may later wish you spent the time and money to create a private placement memo. That is because when you approach prospective investors that you don’t know, it starts to look like what the SEC calls a “general solicitation.” Also, all things equal, it’s safe to say you are more likely be sued by someone you hardly know than someone who stood up in your wedding.
During 2000 and 2001, I was a venture capitalist in Silicon Valley and reviewed well over 300 business plans. But I only recall seeing a handful of PPMs. These were seed and Series A deals. The use of PPMs increases in later rounds when more money is raised and very few of the entrepreneurs who came to us had sophisticated counsel (we had sophisticated legal counsel, although the startups often did not) who would have likely often suggested that their clients create PPMs. Lastly, I was a venture capitalist and we were placing a $75 million fund. That wasn’t huge back then and it’s even smaller, relatively, today. However, people managing funds like that are very sophisticated and unlikely to argue that founders committed securities law violations UNLESS the founders misrepresent things or commit some type of fraud. In that case, the most thorough, well-prepared PPM won’t save you. Don’t ever commit fraud or misrepresent anything at all when raising startup capital. It’s not worth it.
PPMs are Relatively Inexpensive Insurance When Raising Money
Creating a PPM may cost $8,000 – $15,000 with a business attorney that bills at reasonable rates and has done a lot of that work (hint, hint!). Back in my big law firm days, it wasn’t unheard of to see clients paying 3-4 times that. For most startups, even $8,000 – $15,000 is a lot of money. I understand that. In the grand scheme of things, given the risks involved in raising startup capital by issuing private securities, that amount of money can be very inexpensive insurance.
Talk to a Seasoned Securities Lawyer About What Exactly You Need for Your Specific Situation
Securities law is a very difficult and nuanced area of the law. It is important to be careful and align yourself with a securities lawyer who knows what they are doing. I am very upfront with clients, happy to tell them when the DIY approach can be effective. It’s rarely a good option when it comes to securities law. Be smart when raising startup capital and talk to a great lawyer. This doesn’t mean you have to spend a ton of money or always create a PPM. It doesn’t even mean you have to engage that lawyer. It means at a bare minimum you talk things through with a seasoned legal professional and figure out the right decision for you, your cofounders and your startup based on the specific circumstances around how much capital you are raising and who will give you those startup funds.
Helping clients succeed through my own experiences is rewarding (I personally started six companies and raised VC and private investment for three of those). Be smart, do your homework and align yourself with wise advisors.
I am based in Austin, with an office in Houston. I am also licensed in Delaware, the hub of corporate law in this country. No matter where you are, feel free to give me a call at 512.888.9860 with any questions or to talk about what your particular situation calls for in terms of approach and documentation around startup fundraising.
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.