A private placement memorandum is a legal document used by companies to outline investment terms and attract potential investors. It offers information about the company selling securities and related terms and conditions according to the Securities Act of 1993. This information helps investors perform their due diligence towards their stakeholders.
Benefits of a private placement memorandum include:
- Issuer not subject to the US Securities and Exchange Commission (SEC) regulations
- Ability to raise capital quickly
- Lower costs versus preparing a prospectus
- Permissible to maintain confidentiality
- Can raise smaller amounts from a large pool of investors
- Private placement markets are considered more stable versus common stock
- Personalized options and flexibility
There are several key advantages associated with a private placement memorandum. They can help your organization or startup raise capital. However, there are disadvantages to using PPMs as well, so weigh your options carefully.
Here is an article about the Securities Act of 1993.
When to Use a Private Placement Memorandum
The purpose of a private placement memorandum is to help investors understand the investment security or instrument. Smaller and emerging markets, typically involving startups, utilize a PPM when raising capital from a specific group of people. These individuals tend to be high net worth institutional investors.
Examples of when to use a private placement memorandum include:
- Raising business capital for a startup
- Taking advantage of fraud protection statutes
- Offerings above $5 million with unaccredited investors
- Soliciting angel investors with a formal approach
- Negotiating with a large group of investors over fixed terms
- Investing with a lead investor or smaller markets
As you can see, a PPM is not right for every situation. However, they are helpful when raising capital. You should seek immediate, in-state legal advice if you are still trying to decide if this approach is right for you.
Types of Private Placement Memoranda
While private placement memorandum are used to raise capital, they also come in many forms. Several company types can sell unregistered securities versus going through an initial public offering (IPO). For the best result, use the PPM type that is right for your situation.
Types of private placement memoranda include:
- Corporation common stock sales
- Count financing authority bond sales
- Mutual fund shares held in trust
- Limited liability company (LLC) promissory notes
- Mortgage broker business notes
If you are thinking about using private placements to raise money, you must draft a PPM that complies with current regulations. You have the right to use private placements, but only if you meet specific conditions. Otherwise, you could be on the hook for SEC violations.
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Key Parts of a Private Placement Memorandum
Private placement memoranda are formal documents. They are not a business plan since they do not address the business entirely. The most critical point to drive home if you draft a PPM is to ensure that it complies with SEC requirements and that you follow them carefully.
Key parts of a private placement memorandum include:
- Investors’ Notice: The investors should outline important disclosures that prospective investors anticipate seeing. Some common investors’ notices include high-degree of risk, securities transfer restrictions, and company rights. These notices are generally offered following the rules and regulations of the SEC.
- Executive Summary: An executive summary is a letter to the investors that summarize the PPM and point out other critical details. The executive summary should be crafted to entice investors. You should share the top three most important information you want to share so that they can refer to them later quickly.
- Overview and Purpose: The overview and purpose section allows you to introduce your organization and describe what you are using the proceeds for. You can also share your market knowledge, planned operations, and SWOT analysis results. This part will give investors an understanding of who you are, your company’s greater purpose, and how you plan to move ahead.
- Terms and Conditions: The terms and conditions of your PPM are critical to learning about how the deal is structured, including your dilution and dividend policy. Other elements to address include voting rights, liquidation rights, and information rights. If you hire an attorney, they will provide you with a checklist of considerations regarding this section of your private placement memorandum.
- Risk Factors: Risk factors are the most component of your PPM. Potential investors may skip to the section immediately to learn about your company’s risk factors. Statements related to risk should be short, simple, and in bold typeface.
- Financial Statements: Your financial statements and a summary therein share with investors how your company has performed in the past. This section can signal to investors that you can turn a vision into a reality, which is an attractive attribute. Your accountant can provide you with the necessary financial statements that you will need.
- Use of Proceeds: The second most important section is how you plan to use the capital raised. Break your anticipated expenses down into several categories. These categories should match the ones contained within your pro forma documents.
Also, it is worth sharing that the Securities and Exchange Commission routinely warns investors about the warning signs of a potentially fraudulent investment scam or scheme. If your PPM is poorly written, formatted, or generally sloppy, you could turn prospective investors away. Inattention to detail is a significant red flag to an investor.
Private Placement Memorandum vs. Prospectus
The difference between a private placement memorandum vs. prospectus is that a private placement memorandum explains the terms and conditions of a private placement. A prospectus is an offering document that performs the same function but for publicly traded issues, such as companies selling common stock or introducing an IPO. Given you can buy the share in the public markets, there is no need for details about the terms and conditions.
Private Placement Memorandum vs. Business Plan
A private placement memorandum and a business plan have different purposes. A business plan is primarily a marketing tool developed to advance an organization.
- Precision: A business plan intentionally includes information that looks ahead. The strategy will, for instance, describe market demand, customer profiles, expansion opportunities, the competitive environment, revenue channels, and potential strategic partners. A Private Placement Memorandum is a disclosure document with a descriptive, rather than persuasive, tone that enables the investor to assess the investment's merits. The Private Placement Memorandum is presented in a more factual and precise manner. Both internal and external hazards to the firm must be addressed. If a Private Placement Memorandum has a professional appearance, it could inadvertently serve a marketing function. A well-written Private Placement Memorandum will balance disclosure obligations and deal-selling marketing strategies.
- Time: The Private Placement Memorandum must ultimately be given to the investor before any money is taken from them, so better to do it upfront. The business expects the investor to send a check, sign the forms, and return them immediately if they choose to invest. The investors should be given time to reflect and alter their views if they wait to obtain the Private Placement Memorandum. The legal disclosure document needed by Federal Securities Law is the Private Placement Memorandum. Any statements stated in a business strategy are, in all actuality, non-binding. Nobody wants to provide their clients and investors with a document with the same legal disclosure obligations as an advertisem*nt for a used car. The SEC can cancel a transaction if the material in a Private Placement Memorandum is misrepresented by an actual act or simply by omission. Since potential investors don't know the creators, they are comfortable knowing that the Private Placement Memorandum must adhere to a very high degree of truth. Of course, this is advantageous to the inventor.
Capital Raising Through a Private Placement Memorandum
Private equity firms frequently desire to accelerate their growth without taking on debt or going public. A private placement memorandum is also used by a manufacturing corporation, for instance, to raise capital to expand the number of manufacturing units and plants. Once this occurs, the corporation decides on how much money it needs to raise and how much it will pay for each share. In this case, the company requires $1 million to finance its expansion at a share price of $30.
An offering memorandum is first created by the company in collaboration with an investment bank or banker. The Securities and Exchange Commission's (SEC) recommended securities laws are followed by this memorandum. The document is distributed to a predetermined group of interested persons when compliance is confirmed, who are typically picked by the company. In contrast to an IPO which allows the members of the public to buy shares in the corporation, the private placement memorandum gives potential investors all the information they need about the company including the terms of the investment, the nature of the business, and any potential risks involved. A subscription agreement, which serves as a binding legal contract between the issuing corporation and the investor, is nearly always included in the document.
Get Help with a Private Placement Memorandum
For the best result, draft a PPM with business lawyers. They will help you avoid legal mistakes while maximizing your opportunities. Errors can result in expensive consequences and fines in the future, which means you should seek legal advice before utilizing a PPM, prospectus, or other offering documents.
Knowledge and Skills
Business attorneys are well-suited to guide you through the process. They have the knowledge, training, and skills that you want when approaching investors. Solo practitioners and small firms in your state can offer personalized attention, competitive rates, and institutional knowledge.
Personalized Attention
Another benefit of business attorneys is that they offer full-service, personalized attention. They can field calls, write letters, discuss your objectives, and answer questions on-demand. Solo practitioners generally can customize their offerings quickly versus large law firms.
Final Thoughts on a Private Placement Memorandum
Making a private placement memorandum disclosure requires an Issuer to collaborate with a private placement securities lawyer who is well-versed in the rules. The issuer should seek assistance from a company that will help in planning and structuring every area of the offering from the outset because there are several decisions to be taken regarding how to organize the offering and select the proper exemptions. One of the most crucial elements of the memoranda, the risk considerations, must be carefully drafted. An Issuer must be very careful when providing important information in the risk factors section. Counsel must have a complete understanding of the nature of the offering, its strategies or business plan, conflicts, constraints, exits, and other factors in order to deal with specific components of the offering, such as the sponsor's experience and dependence on third parties to the Issuer, in an acceptable manner.
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