Do I Need a Private Placement Memorandum to Raise Investment Capital?
The short answer is that it depends, but it is usually advisable and sometimes required. Let’s dig deeper.
Initially, let’s discuss what a PPM is. A PPM is a document that discloses information regarding the company that is seeking to raise investment capital. In some ways, it is like a business plan, but with detailed additions for investment risk factors, securities law provisions, and the proposed terms of investment. PPMs go by a variety of names – including confidential information memorandums (CIMs) and offering memorandums.
A basic understanding of securities law is necessary to understand how and when PPMs are used. Federal law (and state law) prohibit a company (also known as an “issuer”) from selling securities (think stock and certain kinds of debt) unless the offering is registered or satisfies an exemption from registration. Registering a securities offering is expensive and not appropriate for most companies, so it is necessary for an issuer to satisfy an exemption.
The most commonly used exemption is provided by Section 4(a)(2) of the Securities Act of 1933. It provides an exemption for offerings that do not involve a “public offering.” At first glance, that text may not appear helpful. How do you know whether an offering involves a public offering? There are numerous authorities, including a Supreme Court decision, that help to make the analysis less muddy. However, the SEC has provided several safe-harbors for the “public offering” test. Satisfy one of the safe-harbors, then your offering has complied with Section 4(a)(2) and has satisfied an exemption.
Below is a description of two of the most common safe-harbors and guidance for when use of a PPM is advised.
Rule 504 Safe Harbor. Rule 504 permits an issuer to sell up to $5 million of securities in any 12-month period. Investors can be either accredited or non-accredited, but the issuer may not utilize any form of general solicitation for the offering. Unlike Rule 506, Rule 504 does not preempt state securities laws; therefore, an issuer will need to confirm that a state exemption is satisfied in each state where an investor resides. If the issuer plans to offer securities to non-accredited investors, then Rule 504 is oftentimes the desired exemption since it does not require that certain specific information (e.g., audited financials) be provided to non-accredited investors.
Rule 506(b) Safe Harbor. Rule 506(b) has historically been the most commonly utilized securities registration exemption – partly because Rule 506(b) removes the need of an issuer to satisfy a state securities registration exemption in each state where an investor resides. Rule 506(b) permits an issuer to sell an unlimited amount of securities to accredited investors and up to 35 non-accredited investors. General solicitation is not permitted. Although issuers can technically sell to non-accredited investors under Rule 506(b), the disclosure obligations are burdensome and therefore non-accredited investors should usually be avoided under Rule 506(b).
PPM Required. A PPM is required if the issuer is using Rule 506(b) to onboard non-accredited investors (however, as noted above, Rule 506(b) is not generally advised for non-accredited investors). A PPM is not technically required for Rule 506(b) offers to only accredited investors and Rule 504 offers to either accredited or non-accredited investors. However, a PPM is usually advisable, even in those cases where it is not technically required. An issuer should view the PPM as a type of insurance. If the PPM is carefully and accurately prepared, the PPM ensures that each investor is apprised in writing of all material information regarding the issuer. This is a huge protection against future investor lawsuits – particularly if the investment does not turn out as the investor had hoped and if the investors are outside of the issuer’s immediate circle of friends and family (i.e., more likely to sue!). PPMs are customary in certain industries, including real estate (syndications), manufacturing, restaurants and food service, certain tech, film and entertainment.
Securities law is not an area to forego legal counsel. An issuer needs to select an experienced securities lawyer. That does not have to be cost-prohibitive. Foster Swift offers reasonable flat fees for services of creating a PPM, applicable investment documents, and general securities law counsel. Reach out and we can talk about your business and its fundraising goals.
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