What’s in a Private Placement Memorandum
A Private Placement Memorandum (“PPM”), also known as a private offering document and confidential offering memorandum, is a securities disclosure document used in a private offering of securities by a private placement issuer or an investment fund (collectively, the “Issuer”).
From an investor’s point of view, the purpose of the PPM is to obtain needed information about the Issuer and its securities, both good and bad, to make an informed decision about whether to purchase the security. The investor wants to know the parameters of investing in the Issuer and the potential rights, risks, and rewards of its investment. For the Issuer, the purpose of the PPM is to provide the necessary disclosures about the risks, strategies, management team, investment criteria, and other information about its securities to protect itself and its managers against claims of misstatements or omissions.
Components of a Private Placement Memorandum
A well-prepared PPM will contain several recognizable sections, some of which have greater importance than others. The following are among the key sections of a PPM:
Summary of Offering Terms
The summary of the terms of the offering is just as its name suggests, a condensed description of the offered terms, including the offering structure, the description of the securities (such as the class of securities, securities attributes, etc.), price, minimum subscription amount, investor qualification standards, disclosure of applicable management fees, withdrawals, placement agent commissions (if applicable) and discussion of the terms from the Issuer’s governing documents (limited partnership agreements, operating agreements, etc.) The private placement attorney prepares the summary of the terms of the offering last, as it has the most moving parts.
Perhaps the most important component of the PPM is the risk factors. Risk factors are disclosures of the potential risks investors should consider that could lead to a loss of their investment. Risk factors must be drafted with specificity, tailored for each industry type, offering structure, and investment strategy or business plan.
The Risk Factors section is one area where an Issuer must be particularly careful in disclosing important items. Accordingly, counsel must thoroughly understand the nature of the offering, its strategies or business plan, conflicts, limitations, exits, and more which will allow counsel to deal appropriately with specific aspects of the offering, such as the sponsor’s experience and dependence upon outside parties to the Issuer.
It is highly recommended that a conservative approach to risk factors be taken and that when in doubt, a risk factor should be included on a particular point. The Risk Factors section is included early in the PPM so that it will be one of the first sections a potential investor will read. It provides most of the concerns investors should know about investing in the offering in a single place.
A major mistake that many lawyers make (and even more unwary do-it-yourselfers) is they fail to include detailed, customized risk factors and instead, rely on general risk factors of uniform applicability found in a template. The SEC has indicated the need for specific, relevant risk factors. When Capital Fund Law Group prepares offering documents, the risk factor section occupies a substantial portion of the time spent on the document preparation. Depending on the industry, we routinely prepare PPMs with 20-35 pages of detailed risk factors specific to the offering.
Estimated Use of Proceeds/Expenses Disclosures
A vital component of the PPM is the disclosure of how the proceeds of the offering are expected to be used. A private placement issuer includes a use of proceeds section that contains language describing how the offering proceeds will be deployed, and where possible, we include a table showing item-by-item how much is anticipated to be allocated to each category. It can be difficult if not impossible in many circumstances to determine exactly how much of the proceeds will be allocated to a given purpose. The “estimated” use of proceeds is a best-case forecast of how the proceeds will be used.
Different than an offering for a private placement issuer, an investment fund does not include specific estimated use of proceeds but instead includes a discussion of which expenses that investment fund will cover. The difference occurs because the presumption is that an investment fund will use all after-expense proceeds to invest in the assets that are the basis of the investment fund’s investment strategy.
One point of caution, however, is that the one item that should not be estimated, but firmly stated is the amount of compensation that any related party will take from the transaction, or directly from the proceeds of the offering, whether in the form of salary, fees, consultant payment, purchase or sale of an asset to the Issuer, such as intellectual property, or any other direct or indirect compensation paid to a founder or related party from the proceeds. Note that certain compensation information will also be provided in the Form D filing, which will be publicly available.
Description of the Securities
One of the sections of the PPM requiring the greatest need for a skilled private placement attorney is the description of the securities. In this section, the Issuer discloses the attributes of the debt or equity offering. These attributes are prepared in the governing documents of the Issuer (an operating agreement, limited partnership agreement, shareholders agreement, etc.), or a promissory note (with a debt offering). The description of the securities section describes key terms of the governing document (or promissory note). Thus, it is vital to begin with, the operating agreement before preparing the PPM.
Business & Management Section
The business section describes the investment opportunity and the business of the issuing company. The management section contains biographical and background information about the managers, founders, directors key officers, etc. We rely heavily on the Issuer’s management to provide us with the initial narrative for these sections. The most important factor in preparing the business and management sections is to present information that is free from misleading statements and does not overstate accomplishments or opportunities.
Other Offering Documents
The PPM itself does not constitute the “offering.” The PPM is nothing more than a disclosure document describing the offering, including its structure, strategies or business plan, risks, and management. The offering documents include several supporting documents that should be prepared in conjunction with the PPM. Other documents include the subscription agreement, the investor suitability questionnaire, and most importantly, the Issuer’s organizational documents (an operating agreement, limited partnership agreement, shareholders agreement, etc.), a promissory note (with a debt offering), and others.
In making the PPM disclosures, it is essential that an Issuer work closely with an experienced private placement securities attorney. Our firm will help plan and structure each aspect of the offering from the beginning, as there are many decisions regarding how to structure the offering and select the proper exemptions.
Capital Fund Law Group has authored numerous investment fund publications, including instructive eBooks, white papers, blog posts, and sample offering document excerpts with illustrative footnotes. These complimentary downloads are dedicated to helping fund managers understand the legal fundamentals of launching and operating an investment fund.