As you prepare to make your next offering, it’s important to have every detail in order. And one of the most critical steps in this process is to ensure you have all the necessary documents.
In this article, we’ll walk through investor offer design or what some may call ‘investor proposal.’ While these terms can be used interchangeably, it’s important to understand the value of taking inventory of your documents to ensure your success.
Before diving into exactly what is needed to deliver to your investors, it’s important to understand that documents that are prepared and presented to investors should be reviewed by an experienced attorney. Without proper legal counsel, any mistakes or missteps could result in unexpected costs and legal consequences.
At Crowdfunding Lawyers, our team of experienced attorneys has the knowledge and skills to protect our clients. To schedule an appointment with our office, please contact our office.
What Documents Do You Need for Investors?
When pitching an offer to potential investors, preparing and presenting the right funding documents is important. Collectively, these documents make up the business case to attract and inform investors. They provide a wide range of information to ensure adequate disclosure of the risks and rewards associated with the deal. Additionally, the law requires that you not only disclose crucial information but that you have a plan for your investors.
Funding documents are essential to protect both you and your clients. To prepare these properly, you should be able to organize your cap table and understand how to structure the deal to best suit you and your investors.
These investor documents are the foundation of your offering and, from it, support future aspects of your deal.
What Is a Private Placement Memorandum?
Often abbreviated as "PPM” and sometimes called an “Offering Memorandum,” these documents can be distilled down into information that spells out who, what, where, why, and what could happen in your deal. Any information included in the PPM has the ability to influence an investor’s decision to opt-in or out of your offering.
For example, let’s say that you’re a real estate developer. However, you’ve had a foreclosure in your past. Your natural inclination is to leave that information out because it would undermine the confidence of potential investors, right? However, you cannot do that. If the foreclosure took place within the previous five years, this information must be included for potential investors can make a sound, reasoned decision that is based on accurate, relevant data.
Your PPM should follow the three D’s: disclose, disclaim, and details. First, you should disclose all the material facts. Second, you must disclaim any liabilities. Lastly, you should provide any relevant details to your investors so they can make an informed investment decision.
What Should You Include in a Private Placement Memorandum?
The purpose of your PPM is to provide all information central to an investor’s decision to buy in (or decline) your offering. To do this successfully, you should include several key documents. Let’s break down the information needed to not only impress your investors but also ensure they’re well-armed with accurate data.
Principal Bios and Important Questions to Answer
When it comes to what to include in a PPM, biographies rank near the top. You should draft accurate bios for all the principals in the company. They should explain to your prospects:
- Who they are
- What they have achieved in the past
- What their qualifications are
- Important details to note from their past (the aforementioned foreclosure, for instance)
You’ll also need an in-depth history for the company itself which answers the following questions:
- What is the company name?
- When was it formed?
- Where was it formed?
- How long has it been in operations?
- What is its history?
- Who is the management company (if applicable)?
- What is the history of the management company?
Additionally, you should also answer a series of questions focused on your target investors. These include the following:
- What type of investors are you seeking?
- Will you only accept accredited investors?
- What level of sophistication should they have?
- How many investors are you accepting?
Of course, you also need to provide information about the investment and the expected returns. Some of the questions to answer can include:
- What is the investment opportunity?
- What are your investors investing in?
- What will your investors’ money be doing?
- When will investors see a return?
- What form will that return take?
The Use of Proceeds Question
One important element to spell out in your PPM is how the money received from your investors will be allocated and the purpose for which those funds will be used. When the “use of proceeds” is not appropriately outlined, issues may arise with an offering or when investors aren’t able to see the profitable return that was initially projected.
Part of the “use of proceeds” includes how much the manager will be earning and it’s critically important to include two disclosures that outline what the manager will be earning in this process. The first, a Use of Proceeds Statement, spells out how your proceeds are allocated and how funds are spent. Second, it’s important to include a fee table that outlines the structure of the manager’s compensation.
The Question of Fair and Equitable
You hear a lot about fairness and equity today. But, does it apply to your offering? It may not. What matters is whether the information was disclosed to the investors and whether they agreed.
An Example: The Winery That Failed
To help understand the importance of tracing the money flow and detailing all funding sources, let’s look at a real-world example. The deal was a winery and the investors were told that the only source of funding was the money they put into the deal. Furthermore, they were told that their money would be used to mostly handle old debt, while also being used for operations and to build up the winery.
Ultimately, none of that was true. There was also a significant amount of undisclosed funding from bridge loans, and several lenders foreclosed on the project. In addition, there were up to three deeds of trust on the properties in question. Ultimately, the project failed, and the investors lost their money because of this problem.
How Will Investors Earn a Return?
In addition to disclosing the flow of money through the company and how it will be used, you must also explain where money will come from to repay your investors and debtholders. For example, is it coming from cash flow or is it strictly from disposition? Without clarity here, it leaves your investors hanging.
When Will Investors See Their Return?
It’s simply not enough to detail how your investors will be repaid. They will also expect to know when to predict the return on their investment. Will it be within five years? Seven years? There are investments where investors may never see a return. These deals may likely not have a compulsory return in place, which places the responsibility on the investors to act.
As you can see, there are many details that need to be considered before making your next investment. By following the above guidelines, you’ll avoid any surprises later on.
Outlining Your Exit Strategy
Finally, we need to discuss how the property or business will be disposed of – your exit strategy. What is an exit strategy? Simply put, it’s a plan that details how the property in question will be disposed of or how the business will be structured at the end of the deal. It’s an explanation of how you’ll extricate yourself (and your investors) so you can focus on the next big thing.
Will you take the company public? Will you sell it once it’s up and running profitably? There are many options, but it’s important to develop a smart exit strategy and include this in your funding documents.
Impress Your Investors with a Timeline and Milestones
A timeline can be a useful tool for investors who want to see how their money has been spent. It can also help them understand whether or not they are getting a good return on investment. By outlining a clear idea of where you want to go and how long it will take to get there, then you can set milestones along the way to keep you and your investors focused.
This type of information gives your investors confidence that they’re investing in a sound company with a solid business plan. You should always strive to provide as much transparency as possible. Doing so helps you build credibility among your investors and makes them feel more comfortable about putting money into your venture.
Explain Your Purpose
Your purpose statement is another key component of your investor document. This is a short paragraph that explains why you’re doing what you’re doing. It should clearly state why you’re raising capital and what you hope to accomplish with the funds.
The purpose statement is often the first thing potential investors read after reading your full investor document. If they don’t like what they find, they won’t invest. So, make sure you write a compelling statement that shows your investors exactly why they should fund your project.
The best way to do this is by writing out a list of bullet points that describe your goals and objectives. Then, use those bullets to create a concise, easy-to-read purpose statement.
What Could Happen?
Finally, it’s important to clearly outline the risks your investors may face and assume when entering the deal. By spelling out what aspects could go wrong, you’ll manage expectations and minimize any future liabilities. For instance, COVID-19 will continue to be a risk for many investors for quite some time, but there are many others to consider. Moreover, by providing a full explanation and disclaimer of the risks your investors may face, you’ll limit their ability to in the future to say that they were not properly warned.
By now, you should have a better idea of the funding documents you’ll need and how to design your offer. In next week’s post, we’ll dive deeper into private placement memorandums and everything you should know ahead of your next deal.
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