What is a Private Placement Memorandum (PPM)?
A private placement memorandum, often referred to as an offering memorandum (OM), confidential offering memorandum (COM), or confidential information memorandum (CIM), is a crucial document in the realm of private investments. It is similar to a business plan but places a stronger emphasis on legal issues. The primary purpose of a private placement memorandum is to disclose to prospective investors the terms of a potential investment and the primary risk factors involved. Additionally, a PPM provides a comprehensive overview of the business opportunity, its structure, and management. Unlike a traditional business plan, a PPM is less sales-oriented, as it is typically crafted by business lawyers.
As its name suggests, a private placement memorandum pertains to private transactions and does not involve public transactions. These transactions are not registered with the U.S. Securities and Exchange Commission (SEC).
For a company raising money, known as the issuer in SEC terminology, a PPM acts as a safety belt, offering protection when selling unregistered, private securities. These securities may take the form of stock, other equity interests such as limited liability company membership interests, or even debt instruments. While loans are generally not considered securities, they can be, depending on their structure. Unregistered securities refer to those not registered with the SEC, unlike those of publicly-traded companies, which undergo a rigorous review process.
PPMs provide investors with a thorough company description, financials, terms of the offering, and associated risks. Depending on who drafts the PPM, it may include additional sections and topics. For transactions involving a public offering or securities of a publicly-traded entity, a prospectus would be used instead of a PPM.
The key takeaway is that PPMs are about disclosure in private transactions.
When is a Private Placement Memorandum Required for Raising Private Startup Capital?
Some founders and startup entrepreneurs believe that a PPM is necessary whenever capital is raised or securities are issued in a private offering, including early-stage financing, Series A, and Series B financing rounds. Understanding when a private placement memorandum is required can help clarify this misconception.
However, this is not technically true.
Whenever you issue securities, you must register them with the SEC or find an exemption. Most private offerings are conducted under Rule 506(b) of Regulation D of the Securities Act of 1933, a special type of safe harbor exemption. If you comply with the terms of Regulation D of Rule 506(b), your transaction is considered a private transaction. This is significant because, if deemed a public transaction, you would need to go through the costly process of registering the securities with the SEC and possibly state securities boards before selling them. Consulting a ppm attorney can provide clarity on these requirements.
The term public offering does not only refer to the big initial public offerings (IPOs) often discussed in the Wall Street Journal. It can refer to any offering where the number of offerees or investors or the type of solicitation is such that the SEC considers the transaction a public offering of securities. In a private offering under Rule 506(b), where you raise money from accredited investors, you are not obligated to deliver specific information to prospective investors, provided you do not violate antifraud rules. Rule 506(b) allows companies to raise money from unaccredited investors, although in such cases, you must provide certain information similar in scope to the information required in registered offerings with the SEC.
The SEC website defines an accredited investor as an individual who 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 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 additional definitions of accredited investors that apply to entities like corporations and LLCs.
The takeaway is that if you use the 506(b) safe harbor and only offer securities to accredited investors, you do not technically have to provide the disclosures contained in a PPM. The disclosures and information in a PPM are much less extensive than those in a registered offering.
Do Business Lawyers Advise Preparing a PPM Whenever Raising Startup Capital?
Corporate lawyers understand that entrepreneurs and startup founders do not need a PPM for every capital raise. However, understanding the ppm business meaning can be crucial in deciding whether to prepare one.
In a small deal, such as raising less than $100,000, it may be difficult for founders to justify the cost of a PPM. However, the decision to create a PPM is more about the overall risk profile of how you are raising money than the amount of capital raised. The further removed investors are from your personal network, the more you may wish you had invested in a private placement memo. This is because approaching prospective investors you do not know can resemble what the SEC calls a general solicitation. Additionally, you are more likely to be sued by someone you hardly know than by someone close to you.
During 2000 and 2001, I was a venture capitalist in Silicon Valley and reviewed over 300 business plans, but only a handful of PPMs. These were seed and Series A deals. The use of PPMs increases in later rounds when more money is raised. Many entrepreneurs who approached us lacked sophisticated counsel, unlike us, who had sophisticated legal counsel. Lastly, I managed a $75 million ppm fund, which was not huge back then and is even smaller today. People managing such funds are sophisticated and unlikely to argue that founders committed securities law violations unless there is misrepresentation or fraud. In such cases, even the most thorough PPM will not save you. Never commit fraud or misrepresent anything when raising startup capital.
PPMs are Relatively Inexpensive Insurance When Raising Money
Creating a PPM may cost $8,000 – $15,000 with a ppm lawyer who bills at reasonable rates and has significant experience. In big law firms, clients often paid 3-4 times that amount. For most startups, even $8,000 – $15,000 is significant. However, given the risks involved in raising startup capital by issuing private securities, this amount can be considered inexpensive insurance.
For businesses in Austin, TX, considering a private placement memorandum can be particularly beneficial. The local market’s vibrant entrepreneurial scene often involves complex transactions where a well-prepared PPM can provide clarity and assurance to both issuers and investors.
Talk to a Seasoned Securities Lawyer About What Exactly You Need for Your Specific Situation
Securities law is complex and nuanced. It is crucial to align yourself with a securities lawyer who knows what they are doing. I am upfront with clients, advising when a DIY approach can be effective, though rarely a good option in securities law. Be smart when raising startup capital and consult a great lawyer. This does not mean you must spend a fortune or always create a PPM. It means, at a minimum, discussing your specific circumstances with a seasoned legal professional to make the right decision for you, your cofounders, and your startup based on how much capital you are raising and who will provide those funds.
Helping clients succeed through my experiences is rewarding. I have personally started six companies and raised VC and private investment for three. Be smart, do your homework, and align yourself with wise advisors.
I am based in Austin, with an office in Houston, and licensed in Delaware, the hub of corporate law in the U.S. No matter where you are, feel free to get in touch with any questions or to discuss what your situation requires 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.