Private Placement Memoranda – Do I Need One?

All start-ups know the importance of capital in growing a business and frequently, that capital is generated through private offerings of securities. A strong private placement memorandum, or “PPM,” is one tool a start-up may use in private placements with investors.  Also known as an “offering memorandum” or “offering document,” a PPM primarily serves to provide buyers with information about the company and its offering, but also to help protect the company from the liability associated with selling unregistered securities.

What is a PPM?

As previously discussed, a private placement is an offering of a company’s securities that is not registered with the Securities and Exchange Commission (“SEC”), or state securities regulators, usually relying on Rule 506(b), and is not offered to the public at large.  A PPM is a document that can be used to explain the private placement investment and discloses information about the securities offering and the issuer.  At a minimum, the PPM should contain the information necessary to enable a prospective investor to make an informed decision as to whether to invest in the offering.  This generally includes a description of the company selling the securities, the terms of the offering, and the risks of the investment.

In a traditional private placements (excluding, for instance, the new crowdfunding platforms), PPMs typically are not filed with or reviewed by regulators (with some exceptions such as New York).  Despite not being subject to the same regulatory review and disclosure obligations as registered offerings, PPMs are subject to the antifraud provisions of the federal securities laws.  Any information provided in the PPM must be true and may not omit any material facts necessary to prevent the statements made from being misleading.

Do I Need One?

PPMs can be expensive and time consuming to produce, even where there is a good business plan to act as a base, so the company needs to consider first whether it needs a PPM.

In certain contexts, a PPM, or materials that in substance amount to a PPM, is required. If one or more sales are made to investors who are not accredited, Regulation D requires that detailed disclosures be distributed to all prospective investors in the offering, including the accredited investors.  Rule 502(b)(2) of Regulation D sets forth the specific financial statement and other PPM disclosures required for delivery to non-accredited investors.

No PPM is required in a private placement under 506(b) where offers and sales are made solely to persons the issuer reasonably believes are accredited investors. For this reason, if the nature of the relationship between the issuer and the prospective accredited investors allows it, the company will not use a PPM and will not include non-accredited investors in the deal.  If a start-up company intends to engage in an offering to more than a small number of sophisticated investors, the company should consider preparing a full PPM.  This allows the company to craft its offering with fixed terms that can be circulated easily to potential investors.  As the number of investors grows, providing a PPM is often a best practice in ensuring that investors fully understand their investment and appreciate the attendant risks.  In addition, the PPM can help protect the issuer by disclosing the relevant risks of an investment ahead of time in order to protect the company against any future charges of violating the antifraud provisions of the federal securities laws.

Where only a handful of sophisticated investors are involved, a start-up may choose to forego the PPM in favor of engaging in a simpler approach.  For example, the company may choose to prepare a term sheet and negotiate the terms of the investment with a lead investor (or lead institutional investor) or small group of potential investors before entering into a deal—without necessarily having prepared and delivered a PPM.  In these circumstances, risks to the company can be reduced by having the prospective investors conduct their own due diligence.

What Should a PPM Include?

Although the disclosures included in the PPM vary depending on which exemption from registration is being used, the target investors, and the complexity of the terms of the offering, the following items are generally included in a PPM:

• Introduction. The first pages of a PPM should outline the basic terms of the offering, including an introduction to the company and its business, and any “legends” required by federal and state securities laws.  This section also should include cautionary statements describing the risks of investing in unregistered securities generally and in the offered securities in particular.
• Summary of Offering Terms. The summary of the offering terms often appears in the form of a term sheet and includes the capitalization of the company both before and after the offering.  The summary may also include liquidation preferences, conversion rights, anti-dilution provisions, voting rights, and any other protective provisions for the investors.
• Risk Factors. This is perhaps the most important component of the PPM.  In this section, the company should provide relevant information about the reasonably foreseeable risk factors that may impact the investor’s investment.  The company should make sure to include both specific, relevant risk factors related to the offering and more general risk factors.  Remember, the more meaningful the cautionary language and the more tailored the risks are to a specific company and business, the more protection the PPM will offer from potential liability.  Frequently, PPMs contain boiler plate risk factors taken from other PPMs or from public company filings that are not relevant to the company using them, which tends to limit the cautionary value of such risk factors.
• Business/Management. The PPM typically contains a section about the company’s history and the investment opportunity.  In this section, the company also provides biographical information, special skills, and other background information about its managers, officers and any other key personnel.
• Forward Looking Statement Disclaimer. As noted above, a PPM is primarily a sales document rather than a legal compliance document, and to an extent, a discussion of future prospects of the company (if based on reasonable assumptions) makes sense, but it is important to remind the investor that such forward looking statements are not guaranties of results.
• Use of Proceeds. In this section, the company should describe how the proceeds of the offering will be used.
• Description of Offered Securities. The PPM typically includes a section describing the rights, restrictions, and class of securities being offered.  Ideally, the documents that create those rights (form of certificate of incorporation, form of note (as applicable), stockholders’ agreement, etc.) will be attached to the PPM as exhibits.
• Subscription Procedures. The PPM should provide instructions on the mechanics for participation in the offering.
• Exhibits. Exhibits allow a company to provide supplemental information and documents that may be material to an investor’s investment decision.  Exhibits may include financial statements or projections, copies of investment agreements, organizational documents of the issuer, or key contracts or licenses.