Managing an offering successfully requires a solid understanding of many factors – reporting and disclosure are among the most critical. This can be a major stumbling block for new dealmakers and sponsors. In this post, we will explore one of the most essential disclosure documents: the private placement memorandum (PPM). Note that all information within this post should be considered for educational purposes only.
What Is a PPM?
In the world of securities, a memorandum means a disclosure document. It’s also called a Form S1, filing for a public company, or a Form 1A to file for a Regulation A offering or a Form C for filing a regulation CF offering. Often, PPMs are referred to as prospectuses. However, in the world of Regulation D, where you work mostly with private offerings that aren’t registered with the SEC, and generally, they’re called private placement memorandums.
The memorandum describes everything about the investment you’re putting together or investing in. In terms of length and detail, they can range from 30 pages at the short end to 100 pages at the long end if they include all the exhibits. Either way, the document provides a complete view of the investment’s structure.
With a Regulation D offering, the SEC plays little role. These securities are not qualified through the SEC. Instead, they’re privately placed investments made through specific channels. They’re generally referred to as an exempt or unregistered offering, meaning that the SEC still needs to look at the investment.
That’s not to say a filing doesn’t occur with the SEC. Regulation D offerings are required to be filed so that the SEC can investigate and ensure everything is legal and above board. However, the offering itself is not qualified by the SEC, which sets it apart from other options out there.
It’s also important that these deals are filed at the state level, as well. Most states are very interested in getting their filing fees, which go directly to their budgets. With a Reg D offering, the sponsor must file in every state where an investor resides. This makes it critical for sponsors and dealmakers to do their due diligence and gather accurate information from investors about where their primary residence is located.
How Widespread Are PPMs?
A casual glance at the investment market might be enough to convince most people that there’s a great diversity of options out there. While investors do have ample opportunities to grow their wealth, the truth is that private placement memorandums account for most investments sold in the United States. Regulation D plays a central role in raising capital for most companies these days.
You can spend up to $1 million attempting to get onto the New York Stock Exchange. NASDAQ requires multiple types of registrations and other steps to be listed. However, only so many businesses can reach these lofty heights. Most never do. With Regulation D offerings, there is no limit. There are more Reg D offerings than companies listed on the world’s stock exchanges combined with the Regulation A and Regulation CF offerings combined.
A Brief Historical Grounding
In 2017, over $3 trillion was raised through these unregistered securities, and $1.85 trillion was raised through Reg D offerings. Only 9% of the investors within those deals were unaccredited. Private placements are often limited to accredited investors or large, institutional investors, sometimes called qualified purchasers, meaning they have $5 million or more in assets.
When speaking of an accredited investor versus a nonaccredited investor, “accreditation” means they have a net worth of $1 million or more, not including any positive equity from their principal residence. However, there are other ways to calculate this. For instance, if the investor has earned $200,000 a year for several years (or $300,000 with a spouse), they can be considered “accredited” based on their income alone.
For dealmakers and sponsors, the point is this: you must continually look back over the last few years of an investor’s financial life to determine if they fit well with your offering. Anyone who fails to meet the accreditation requirements is considered nonaccredited. In the Regulation D space, there’s one option, Regulation D, rule 506 c, that doesn’t allow for any nonaccredited investors. There’s also Regulation D, rule 506 B, that doesn’t allow you to advertise or market your opportunity. However, you can accept 35 or fewer unaccredited investors.
The Purpose and Scope of a Private Placement Memorandum
A private placement memorandum is a legal document describing important facts about a private investment. Its real purpose is to provide the investors with all the information necessary to decide whether to invest on the sponsor/issuer side. Finally, a PPM also protects the sponsor from investor claims that they were not forewarned about specific risks. Most PPMs have 10 to 15 pages dedicated specifically to different risk factors and ways investors may lose some or all their money.
That type of disclosure sounds like a terrible thing to put into a sales pitch for an investment. However, understand that a PPM is not a sales tool. It is a disclosure document that ensures transparency for investors and protection for sponsors. It’s a vehicle that allows sponsors to deliver a very wide range of critical information to investors, including:
- Details about the company
- Information about the management team and methodology
- Data about controls in terms of voting
- Details about fees and costs
- Information about how profits are split.
- A detailed list of all the ways an investor could lose their money.
How Long Should a PPM Be?
Most PPMs are usually 30 to 100 pages. They’re also written in plain English, with little to no legalese that might confuse investors. It should be simple, understandable, and clearly laid out to foster understanding with investors. The best way to think of this is that anyone should be able to read it and completely understand it even if they have no financial training or experience.
The PPM is usually supported by exhibits of the various legal agreements required to make a deal happen. For instance, there might be an operating agreement or company agreement in the case of an LLC. If a corporate structure is being used, there could be bylaws. You can even offer debt, asking investors to sign on to promissory notes.
The abovementioned legal documents serve as legal clarifications and are attached to the PPM. Investors can read about the agreements in the PPM but those with deeper analytical needs can peruse the legal documents themselves.
Marketing Materials and the PPM
PPMs include more than the basic summary of the business and supporting legal agreements. They can (and should) also include marketing materials. Sponsors want to provide investors with important information about the investment, expectations, business plan, and more, and that involves things like pitch decks and brochures. These are included as exhibits/attachments and are not part of the PPM itself.
Again, this is all about ensuring investors can make an informed decision. They need information about risks, but also about the potential rewards, which is where marketing collateral enters the picture.
The Subscription Booklet
One of the most important things is the subscription booklet, the suitability questionnaire for the investors to gather their background information and qualify them to invest. Are they accredited or nonaccredited? If they’re nonaccredited, do they have the work or educational experience to help them understand there’s a chance of losing their investment?
Even if the investor is suitable, ultimately, they sign an investment agreement. Often, it’s called a subscription agreement. The terms are interchangeable and indicate both the issuer and the investor are making representations and agreeing to the investment terms.
A PPM is a critical component of any investment opportunity. It provides essential information for potential investors, allowing them to make an accurate decision based on all the relevant details. It also protects the sponsor from claims that an investor was not warned about the risks involved should the investment fail.
Creating a PPM requires a solid understanding of the components, the investment in question, and the audience the offering is aimed at. Even with those in place, it can be a delicate process and is best handled by an attorney with considerable experience.
Not sure how to put together a PPM for your deal? Need guidance throughout your offering? Contact us today to schedule a consultation and learn how Crowdfunding Lawyers can lay the groundwork for a successful offering.