Private Placement Memorandums
When raising money from investors, it’s common to issue a document known as a private placement memorandum (or sometimes called an offering memorandum) in order to comply with one or more exemptions to registration under federal and state securities laws. A private placement memorandum (or PPM) is a disclosure document that the business issues to potential investors who are considering investing in the document. As the name implies, PPMs are used in private offerings, i.e., offers to invest in companies that are not publicly traded, including privately owned businesses. The PPM provides investors with quite a bit of detail about the business they will be investing in as well as all of the material terms of the investment deal.
Why does a business need to issue a private placement memorandum?
Generally, a business will issue a PPM to its investors in order to comply with either the general private placement exemption or the more specific Regulation D Safe Harbor provisions. Under the general private placement exemption, investors must be given access to the type of information normally provided in a prospectus for a registered securities offering. The Regulation D safe harbor provisions provide more detailed information to help businesses qualify for one or more of the exemptions.
There are three Regulation D exemptions (Rules 504, 506(b), and 506(c)), all of which require a notice filing on Form D with the SEC within 15 days after the first sale of securities in the offering. Form D puts the SEC on notice of the amount and nature of the offering being undertaken in reliance on the exemption from registration.
Rule 504 – Seed Capital Exemption
Rule 504 exempts the offer and sale of up to $1 million in securities in a 12-month period. Businesses cannot use general solicitation or advertising to market or sell the securities, and the securities are restricted, meaning that the investors cannot find a new buyer to get rid of their securities without first registering the securities or complying with one of these exemptions from registration. This exemption also cannot be used by so-called “blank check companies,” i.e., those that have no specific business plan or purpose or simply plan to merge with or acquire unidentified companies. Rule 504 isn’t commonly used simply because of the dollar limit.
Rule 506(b) is the most common “safe harbor” for private placements. Put simply, this rule provides specific requirements that, if followed, firmly establish that the transaction falls within the private placement exemption.
To qualify for the safe harbor, the business must:
How do we determine if our prospective investors are sophisticated or accredited?
Generally, an investor questionnaire is used to qualify prospective investors and determine whether they are accredited or at least sophisticated investors. In light of the anti-fraud provisions in securities laws, companies seeking investors generally provide the same information to both accredited and non-accredited investors in the form of a private placement memorandum and give prospective investors the opportunity to ask questions and conduct their own due diligence (usually in the form of a conference call with the company’s principals and legal counsel).
Which private placement exemption should your business rely on?
If you plan to advertise that your business is seeking investors, then you will most likely have to rely on Rule 506(c) because it is the only federal exemption that permits general solicitation. But because Rule 506(c) requires that all of the investors are accredited, this option is often not available to businesses, who often rely on Rule 506(b) to include non-accredited “friends and family” investors.
As a practical matter, the only real-world difference between the Section 4(a)(2) exemption for private placements and the safe harbor Rule 506(b) is the filing of Form D. If the company relies on Rule 506(b) and files Form D, then the states are preempted from requiring that the securities offering to be “qualified” by the state. Each state where the company has investors may still require a notice filing (and an associated filing fee), but the company does not have to wait for the state to approve the offering to begin seeking investors. Without a Form D, the company must look to the blue sky laws of each state where it will have investors and confirm that each state has an applicable exemption from registration.
Your business may also wish to avoid filing Form D to avoid disclosing confidential or sensitive information to their competitors.
What should be included in a private placement memorandum?
The private placement or offering memorandum will typically describe the business and its key officers or managers, the business’s plans, financial statements, and the details of the investment opportunity being offered. It should also explain what the business plans to do with the investment dollars raised and the risk factors associated with an investment in the business.
While much of this information may already be in your business plan, the PPM should be carefully tailored to comply with the legal requirements of any exemption from securities registration the business is relying upon. You may come across bad internet advice telling you not to bother with a PPM or to simply do it yourself using a free or cheap internet form, especially when raising money from friends and family. But even close friends and family may turn against you if the investment doesn’t work out. When that happens, do you want to face a lawsuit for securities fraud? Or do you want to have the legal documents in place to show that you tried to do everything right?
If you are considering raising money from investors, then schedule a consultation with sophisticated legal counsel who understands the needs of serious entrepreneurs.