20 May When raising capital, why use a Private Placement Memorandum?
Editor’s note: Matt Storms is writing a series of articles on raising capital from angel and venture capital investors. This installment focuses on the Private Placement Memorandums, or PPMs, and is co-written with Dan Ghoca.
We are frequently asked whether it is necessary to use a private placement memorandum (also referred to as a PPM or an offering memorandum) when selling securities to angel investors in a private placement. Once we tell them “yes, it’s generally a good idea,” the next question that frequently is asked is “what does a PPM require?”
The answer to this question is somewhat more complicated and often dependent upon to whom the offering is being made, and in some cases the location of the prospective investors.
Before going into more explanation on that, we will explain why companies should use a PPM.
It may be required by law
In certain contexts, especially when offering securities to prospective investors who are not accredited, a PPM is required. In such situations, the contents of the PPM may be more or less dictated by the disclosure requirements of the applicable securities regulations.
Protection against securities fraud claims
Even when law does not mandate written disclosures, the statements of the issuer (oral or written) are still subject to the federal and state anti-fraud requirements. When offering securities to an investor, the issuer must not make any untrue statements of a material fact, or omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading. (In other words, the issuer must not make any “half truth” statements – the issuer must fully disclose all relevant and material facts).
If a material misstatement is made, regardless of whether it is intentional, the investors may have a securities fraud claim against the issuer and possibly its officers and directors as well. In addition, the Securities and Exchange Commission can impose civil and criminal penalties, too. A well-prepared PPM helps to avoid a securities fraud claim. It establishes the record of what was communicated to the investors about the offering and the company.
A good, professional-looking PPM delivered to prospective investors can become an effective “sales” document. It communicates to the prospective investor that the directors and officers of the issuer are serious about their business, that they know the company and the industry they are in, and that they are professional and know how to deliver a good product.
Contents of a PPM
Once a company chooses to use a PPM, the company next must decide what goes into it. In some contexts, because many securities law regulations are intended to protect those considered less sophisticated or less able to bear the risk of certain investments, law dictates the minimum contents of the PPM. If the private offering has at least one investor who is not accredited, it is likely that the issuer will have to make detailed disclosures. This typically drives up significantly the time to prepare the PPM and the associated legal costs. As a result, it has been our experience that most offerings are limited to accredited investors only.
For offerings where there is little or no formal mandatory disclosure requirement (such as when an offering in which is made to only a few investors from the same state and all the investors are accredited), the PPM should contain at least the information necessary to enable the prospective investor to make an informed decision as to whether to invest.
Thus, below is an example of what we might suggest in many contexts to include in the PPM, although the actual contents of the PPM may vary depending upon the particular offering or circumstances of the company.
• Cautionary language: Includes several cautionary statements describing the risks of investing in unregistered securities generally and the offered securities in particular.
• Summary of Offering Terms: Is often in table format and is usually in the form of a term sheet (see article on term sheets).
• Description of the issuer: Describes the issuer, organizational structure, cap table, a brief history of the company, and context of the offering.
• Business plan: Provides information on the market opportunity, the company’s value proposition, its products, marketing and sales plan, management, financials, proposed use of proceeds, etc. The brunt of an issuer’s business plan is typically the centerpiece of the PPM.
• Risk factors: Includes those risk factors foreseeable by the issuer that may bear on the investor’s investment, including those risks common to similar investments generally and those risks unique to the issuer and its securities. For example, risk factors can include challenges that the company may face in forthcoming clinical trials, or it may include some difficulties the company may face with cash flow while it expands its operations.
• Subscription procedures: Provides instructions on the mechanics for participating in the offering.
• Conflicts of interests: Consists of a summary of relevant or possible conflicts of interests of the issuer, its principals, its affiliates, or a combination of one of the foregoing. For example, the CEO of the issuer may have an outside an interest in another company that provides services to the issuer.
• Appendices: Contains supplemental information and documents that may be material to an investor’s investment decision as to whether to invest. The appendices may include copies of the actual investment agreements (instead of just summaries in the PPM itself), detailed financial statements or projections, the organizational documents of the issuer, material agreements or licenses, etc.
In summary, it is virtually always a good idea to use a PPM when offering securities to angel investors. The investors to whom the offering is being made often drive the contents of the PPM and the costs associated with putting it together.
Previous articles by Matt Storms
• Matt Storms: Capital-raising term sheets for angels and venture capitalists
• Matt Storms: Translating the language of capital-raising
• Matt Storms: Securities compliance is part of raising capital
• Matt Storms: Raising capital through placement agents
• Due diligence and corporate clean-up
• Matt Storms: The mechanics of raising capital for your business
• Sarbanes-Oxley for the Rest of Us
Dan Ghoca is a member of the Business Practice Group at Michael Best & Friedrich. His practice focuses on mergers and acquisitions and general corporate law.
The opinions expressed herein or statements made in the above column are solely those of the author, and do not necessarily reflect the views of the Wisconsin Technology Network, LLC.
WTN accepts no legal liability or responsibility for any claims made or opinions expressed herein.