What is a Private Placement Memorandum?
A private placement memorandum is a document, sometimes called a prospectus, offering circular, or PPM, which explains an offering of securities and the risks associated with it. The majority of startups and emerging growth companies raise money through private placement memorandums. The reason they are referred to as private is not because the company seeks private investors, but because the offer and sale of stock (a security) does not involve any public advertising or general solicitation of investors. Since many companies do not have the money or resources to file a registration statement with the Securities and Exchange Commission, they rely on exemptions from registration to sell their securities.
The most common exemptions utilized by our San Diego business attorneys under federal securities laws (Securities Act §3(b)) include:
Regulation D: Private offer and sale of securities requiring compliance with the manner of offering requirements and limitations on resale of securities requirements. Common categories utilized by companies are:
Rule 504 – company may raise up to $1 million within a 12 month period; no specific information requirements for PPM;
Rule 505 – company may raise up to $5 million in a 12 month period; unlimited number of accredited investors and only up to 35 unaccredited investors; 502(b) information disclosures required;
Rule 506 – company may raise an unlimited amount of money within a 12 month period to accredited investors; unlimited number of accredited investors and up to 35 unaccredited but “sophisticated” investors; Rule 502(b) information disclosures required;
Note: If Rule 505 or 506 placements are only sold to accredited investors, there is no information specifically required to be provided. If there is even one non-accredited investor, the company must provide (unless they are already a reporting company with the SEC) certain financial and non-financial statement information.
Pursuant to the Dodd-Frank Act, the term “accredited investor” includes a number of categories to qualify based upon the investor’s recent income and net worth. However, the Act limits the definition for net worth so the investor’s primary residence is not included as an asset for purposes of calculating net worth and a mortgage on their primary residence is not included as a liability (with certain exceptions).
What is the Purpose of a Private Placement Memorandum?
Even though a sale of securities may be exempt from registration and have limited or no information requirements to provide to potential investors, the private placement memorandum must still comply with the anti-fraud requirements of the federal Securities Act as well as state securities statutes (known as Blue Sky laws). Given the potential complexity and length of such compliance, a private placement memorandum may run 25 to 75 pages.
The core concept underlying securities laws is “disclosure”; investors must receive enough information from a company selling securities for them to evaluate the risks involved and determine if they are willing to accept those risks.
What are the Benefits of a Private Placement Memorandum?
As any experienced San Diego business lawyer can tell you, no one can guarantee that the SEC, state regulators, or private investors will not pursue claims against a company or management. However, there are steps you can take to limit any potential exposure, including having a private placement memorandum and related documents prepared by an experienced attorney. Depending on the exemption used for the number and level of investors, time for funding, and amount of money being raised, there can be differing requirements for what must be provided in the PPM. Even if an exemption does not expressly require something to be disclosed to investors, best practices may dictate that disclosure be made to protect the company and management from the risk of liability.
Officers and directors of the company have a heightened interest in ensuring that proper disclosure is made through a PPM in order to avoid the potential for personal liability should an investment go sour. If you include statements in a private placement memorandum which materially misstates the facts, are misleading, or if you omit material facts, you risk not only civil penalties, but serious criminal penalties as well. It is always best to hire a licensed attorney to assist you in this process. You can save time and money, and more down the road, by creating a good business plan internally, then have your San Diego business attorney edit it as necessary to comply with applicable laws. Contact us today for more information or to get started. We’re here to help.
Here is a link to the California Department of Business Oversight’s securities law publications for additional information: