What is a Private Placement Memorandum?
A Private Placement Memorandum, or “PPM,” is a disclosure document often used in connection with a private offering of securities. It contains a compilation of information about the company issuing the securities, the terms of the securities, and the risks of investing in those securities. This article explains the legal background underlying why a PPM is commonly used and overviews what is typically included in a PPM.
Why Use a PPM?
Put simply, a PPM is used to inform potential investors about an offering of securities. The amount of disclosures included in a disclosure document like a PPM varies among private companies that are selling securities with some companies including a very detailed PPM to others choosing not to include any formal disclosure document to their investors. How does a business owner seeking to raise capital or a company officer involved in a securities offering know if the company, or “issuer,” should be distributing a PPM to potential investors? To answer this question, let’s first consider the legal background underlying why PPMs have become common practice for issuers.
The Securities Act of 1933 (the “Securities Act”) governs securities offerings and requires that all offerings of securities be registered with the Securities and Exchange Commission (“SEC”) or meet the requirements of a registration exemption. One of the most commonly used registration exemptions is Section 4(a)(2) of the Securities Act, which exempts those offerings which do not involve a “public offering.” Offerings that rely on Section 4(a)(2) are commonly referred to as “private placements” since they are intended to not involve a “public offering” (hence the name Private Placement Memorandum). Registering an offering with the SEC is an expensive and lengthy process and therefore, private issuers often go to great lengths to fit under the Section 4(a)(2) exemption.
There is a lot of guidance from the SEC on what is and is not considered a private offering of securities. However, the spirit of this guidance revolves around accurate disclosures to potential investors, with the degree of those disclosures being on a spectrum: less sophisticated investors needing more disclosures and more sophisticated investors needing less disclosures. Furthermore, securities laws require those disclosures to be accurate and not misleading. Since a PPM formally memorializes what you are telling potential investors about your company and its offering, it is a great tool to (i) assist an issuer in providing appropriate information to potential investors and (ii) comply with securities laws governing these disclosures.
What is typically included in a PPM?
Now that you have an understanding of why you may want to use a PPM, let’s turn to what is typically included in a PPM. For the vast majority of private offerings, the securities laws only provide guidance on what may be disclosed in a PPM as opposed to specific requirements. The majority of the SEC’s resources are, understandably, spent on reporting companies (think Facebook and Apple), which do have disclosure requirements. Due to this focus, most of the SEC’s guidance is related to these reporting companies. That being said, private offering practitioners have customarily taken this guidance and applied it to private offerings.
The most commonly included sections of a PPM are (i) a description of the issuer, (ii) a description of the terms of the offering, (iii) certain risk factors and disclosures, (iv) a subscription agreement and investor questionnaire, and (iv) a summary of any material agreements. Although these are the common elements of a PPM, every situation differs.
Description of Business. To convince someone to invest in your company, you have to tell a good story. To do this, you must accurately depict your business, which is the reason a description of the business is often one of the first sections in the PPM. However, from a legal perspective, you must be careful in crafting this section so that you do not violate the prohibition against the use of fraud, materially false statements, omission of material information, or other acts to deceive another person with respect to the offering or selling of securities. Committing securities fraud could result in an adverse judgment, penalties, fines, and even a right to rescind the purchase of securities. To further protect the issuer from claims of fraudulent sales, an issuer may also give prospective investors access to key corporate documents and source material to back up the information in the PPM.
The Offering. This section often describes the terms of the deal and generally, a broad summary of the main documents involved in the deal (e.g., corporate documents and stockholders agreements). Questions often addressed in this section include: how much equity is being offered, price of the shares, whether there a minimum purchase amount, what rights investors will have, and who is eligible to invest.
Certain Disclosures/Risk Factors. Disclosures and risk factors are especially important in addressing the anti-fraud provisions addressed above. This section of the PPM describes in detail the risks associated with your business. Although your inclination may be to limit your risk disclosures because you do not want to “scare” off investors, it should be the section you spend the majority of your time. As mentioned above, securities laws (especially with respect to reporting companies) guide PPM disclosures. To illustrate the importance of drafting these risk factors carefully, consider the case where the SEC initiated an action against Mylan N.V. (“Mylan”), an SEC reporting company. The SEC alleged Mylan violated Section 17(a) of the Securities Act because Mylan disclosed in its SEC filings that there was risk that the Centers for Medicare and Medicaid Services (“CMS”) “may” take the position that its submissions to Medicaid were incorrect when, in fact, CMS had already told Mylan that it was misclassifying one of its drugs resulting in incorrect submissions. In other words, instead of disclosing that CMS had already disagreed with Mylan’s classification of one of its drugs, Mylan misleadingly used the word “may” and presented it only as a potential risk. This example highlights how accurate companies should be in disclosing its business risks to its investors. (Cite: See sec.gov/news/press-release/2019-194; https://www.sec.gov/litigation/complaints/2019/comp-pr2019-194.pdf)
Subscription Agreement and Investor Questionnaire. In order to purchase securities, an investor generally needs to complete some form of a subscription agreement. This agreement governs the actual purchase of securities (e.g., how much is being bought, when must funds be transferred and how, etc.). Investor questionnaires are also commonly included. Not only does a questionnaire provide the issuer with the investor’s contact information, it is also helps the issuer comply with the appropriate private placement exemptions from the SEC’s registration requirements. For example, if an issuer is relying upon the Rule 506(b) safe harbor, generally the issuer will limit the offering to accredited investors, and an investor questionnaire gives the issuer a reasonable belief that the investor is an accredited investor.
Summaries of Material Agreements. Lastly, PPMs also often include summaries of the material deal documents. Generally, these summaries are more in depth than the summary of the offering section addressed above. Depending on whether the issuer is a corporation, limited liability company, or other entity, certain governing documents may also be attached. For example, a corporation might attach its certificate of incorporation which includes information on the class of shares offered, while a limited liability company might attach its limited liability company agreement which sets forth the rights and obligations of its members.
In summary, a PPM is presented to investors to inform investors about the offering, mitigate certain risks to the issuer associated with the offering, and to actually sell the securities. While many types of offerings do not require a PPM to be delivered, it’s helpful to think of the resources spent preparing securities disclosures like purchasing insurance. The more put into preparing the disclosures, the more those disclosures will protect against risk of potential securities laws violations.