How to Write a Private Placement Memorandum + Template

A private placement memorandum (PPM) is a document that private companies use to sell shares of their company to investors. In this article, you will learn more about what a PPM is and what needs to be included in it.

What is a Private Placement Memorandum?

A private placement memorandum (PPM) is a document that private companies use to sell shares of their company to investors. It details all of the terms of the investment, the requirements of the prospective investor, and proper disclaimers and disclosures related to the business and the equity.

A private placement is an equity or debt offering that does not have to go through the detailed paperwork and expense of registering with the SEC because it meets legal exemptions.

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Laws Permitting Private Placements

While there are numerous laws permitting types of private placements, the most commonly used are based on Regulation D (often called Reg D) in the Securities Act of 1933.

Reg D has separate exemptions for companies raising capital of under $1 million, under $5 million, and unlimited amounts, each with slightly different restrictions. The rules generally refer to a prohibition on general solicitation or advertising to promote the private offering, sale only to accredited investors, and restrictions on the resale of the securities.

Other types of private placements include Rule 144a Convertible Transactions and Reg S Transactions. A Rule 144a offering is sold only to Qualified Institutional Buyers (QIBs), which are institutions managing over $1 billion in assets. These debt offerings use convertible debt or convertible equity and are often sold to a financial agent (broker-dealer) and then resold to QIBs. Reg S allows private offerings to foreign investors.

Key Components of a Private Placement Memorandum

A Private Placement Memorandum (PPM) includes key sections that tell potential investors more about your company and offer to sell securities.

• The term sheet outlines the investment terms, while legal disclaimers cover regulatory compliance.
• A risks section highlights potential business and market risks.
• The capitalization table, usually in the financial section, shows the company’s ownership structure and potential dilution from the capital raise.
• The PPM also includes a subscription agreement, which is the contract investors sign to make the investment.
• Finally, the PPM includes either a full or abbreviated version of your business plan, explaining to prospective investors in detail what your company does, your industry, customer and competitive analyses, and your marketing plan and financial projections among other things.

PPM Term Sheet

The term sheet of a PPM details the specific terms and nature of the investment. This is not as simple as explaining the price at which each share is being sold. Depending on how the business is incorporated, there are different options for the types of equities that can be sold through a private placement. For example, common stock, preferred stock, and convertible debt are all types of securities that can be sold in a PPM.

The terms of the investment will also be detailed in the PPM term sheet. For instance, how long the investor has to hold onto the securities before selling them (the lock-up period), what rights the investor has as a shareholder, and what type of return the investor can expect.

It is important to note that the PPM term sheet is not legally binding. It is simply an agreement between the issuer and the investor that outlines the terms of the investment. However, once both parties sign the term sheet, it becomes much harder to back out of the deal.

Types of Securities

There are two main types of securities that can be sold in a PPM: equity shares and convertible debt.

Equity Shares – Membership Units and Stock

Equity shares are the most common type of security sold in a PPM. They represent ownership in the company and entitle the holder to voting rights and dividends (if declared). Common stock is the most well-known type of equity share.

If the business is incorporated as an LLC or limited partnership, shares can be sold in the form of membership units in the company. These membership units can be preferred or general units. Preferred units generally carry stipulations that they will be paid dividends first, but may offer no voting rights (much like a limited partner).

If the business is incorporated as a corporation, shares can be sold directly to accredited investors. In either situation, you are sharing ownership with the investor and must keep in mind that ultimate control goes to the party or parties with more than 50% of the shares. If you are selling more than this, understand that you may be giving up control of your company.

Convertible Debt

Instead of selling shares directly to accredited investors, convertible debt can be sold. Although there are many types of convertibles, these instruments (sometimes called convertible debentures, convertible loans, or convertible bonds) usually start as loans or bonds with a stated interest rate. This offers investors a guaranteed return over the first few years. At a specified date, the debt may be converted to ownership shares based on some method of valuation chosen previously, or the principal can be paid back to the lender. It is up to the investor whether to get his or her money out at that time or to become a stockholder.

This method shares some similarities with equity and some with debt. Like debt, it lowers the initial risk to an investor by offering a guaranteed return. Like equity, there is greater upside potential in the long run. This is a good option for cash-generating start-ups who would like to postpone having to value their company until a later date. Hopefully, by the time of the conversion, the sales and profits track record will support a higher company valuation. This means you will not have to give away as much equity to investors as you would have during the initial capital raising.

Legal Disclaimers

Some of the most important legal disclaimers are disclosures made at the opening of the PPM document and disclosures about the general and specific risks of the investment.

Opening Disclaimer

Immediately after the cover sheet and table of contents of the private placement memorandum, an initial disclaimer must present the reader with the limitations of what the document that follows can and cannot be used for.

For example, it should classify the document as confidential and not to be distributed or reproduced. It should disclose that the offering has not been registered with the SEC and detail what exemption it meets from registration.

It should remind readers that the contents of the PPM are valid only on the date of the document and that such information may change after that date. All of these types of disclaimers, which a lawyer should review for you, are created with the express purpose of protecting your firm from investigation by the SEC or claims of fraud or wrongdoing by investors and prospective investors.

A confidential private placement memorandum (PPM) presents an opportunity both to sell your privately offered securities to investors and to protect your firm’s interests. It is important to keep in mind that, while you do want the document to compel prospective investors to move forward, if they do so without a full understanding of the risks related to your business, you open the door to legal action and investigation by the Securities and Exchange Commission (SEC).

Much in the same way that prescription drugs must explain risks in public advertisements, securities must do the same. While health and life is at stake with prescription drugs, the savings and financial security of investors are at stake in a private placement due to the volatile nature of the returns they can expect.

Risks

The risks involved with investing in your company must be laid out carefully in your private placement memorandum not because of a government requirement to do so (the federal disclosure requirements are limited, although you should consult with a lawyer who knows both federal securities laws and other applicable state securities laws). Disclosing these risks clearly before investors write you a check is the best way to protect your firm from lawsuits claiming you defrauded or misled them.

General Risk Factors

Within the PPM, the risks associated with investments of this type must be repeated, no matter how obvious you believe them to be for sophisticated accredited investors. For example, you must explain that the value of the shares can drop or go to zero, and detail the types of trends that could influence the success of the company. You should explain known risks in your industry to clarify that your industry’s health is not fully certain in the long term.

Specific Risks

Your PPM needs a section that discusses the risks your company faces. For example, if your firm’s competitive advantage is built around intellectual property, there is a risk that the property could be stolen by another firm or better intellectual property be developed.

If your firm’s advantage is partially built on the specific management team members, there is always the risk of one or more of them leaving the firm. Focus on what you see as the primary risks first and work your way down to the lesser risks.

Capitalization Table

A capitalization table (or cap table) is an important part of your private placement memorandum (PPM). It lists the shareholders of your company and shows their corresponding ownership shares along with voting rights and other specifics. It is typically shown in chart format with accompanying notes.

Pre-Money and Post-Money Ownership

The cap table can be used for your own purposes to better understand how your percentage ownership will change with the current capital raising round. This is important to understand, especially if the financing results in the original owners losing the necessary 50% of voting rights which gives them control of the company. A lawyer may be so focused on protecting you from legal liability that they do not adequately explain how you can keep this control, even through a significant round of funding.

If you can raise a smaller amount and spend more time proving your business model with this limited amount of financing, you can avoid giving up controlling interest in your company both now and in a future round of financing. By the time of the second round of financing, you will likely have sales revenues history and greater demonstrated interest from customers, all supporting a higher pre-money valuation of the company.

Common, Preferred, Options, Warrants

It is important that the cap table go into the specifics, by differentiating between common stock and preferred stock. Preferred stockholders generally hold no voting rights but are paid dividends before common stockholders. Therefore, to keep control over the company, issuing preferred stock may be the way to go. However, savvy investors may want the control that comes with voting rights more than additional dividends if they believe their influence can help improve the value of the stock overall.

The cap table should include lists of options or warrants that have been issued or will be issued as well. This gives both management and prospective investors a full picture of potential future changes in ownership if and when the options or warrants are executed.

Subscription Agreement

The subscription agreement gives the necessary information for a subscriber to move forward with investing in your private placement. This includes the price per share and the number of shares being acquired.

Legal language explains necessary confidentiality provisions, which state governs the agreement, and the rights and requirements of the subscriber. The agreement also should require the subscriber to certify that he, she or they are accredited and have not been solicited so that the seller has a record that the proper procedures were followed.

While you will be seeking to gather all of the necessary legal information with this agreement, still make an attempt to keep the subscription agreement as simple as possible. For example, rather than repeating or outlining any of the disclosures made in the private placement memorandum here, the agreement should simply repeat that the subscriber has read and understands the PPM in its entirety.

Paraphrasing any of those disclosures here can lead to confusion. Clearly state and leave adequate space for the information needed from subscribers and give careful instructions as to where the agreement and checks should be sent or wire transfers made.

Although there is a bit of leeway you can take to make the subscription agreement more attractive to potential subscribers, it is primarily a legal contract which must be carefully vetted by legal counsel. It should describe, for example, whether the funds will be kept in escrow until a critical mass of investment has been received. This is a common tactic which protects investors in the case that the required funding is not raised by a certain point. If that is the case, the funds would be sent back to them rather than being released to the seller. Ask your legal counsel about whether this arrangement is needed for your offering.

It is important to make sure potential subscribers are aware that they can contact your firm directly to ask questions about the private placement offering and to learn more for their own purposes of due diligence. Some federal exemption rules even require that the seller make him or herself available to answer potential investor questions. Detail the best ways to contact your firm or its broker representative in the subscription agreement.

The Business Plan Section of your PPM

The section of your PPM that typically encompasses the most pages is the description of your business and plan for success. Here you will show projected and historical financial statements, and some detail on the management and operations of the business. You will also provide industry analysis and your marketing plan.

Business Plan vs. Private Placement Memorandum

There is much overlap between a business plan and a PPM. Essentially, a PPM includes your business plan along with the other sections mentioned above.

A business plan alone cannot be used to sell securities. Only a PPM can do this. Unlike a business plan, a PPM also includes risks and disclosures.

Conclusion

A private placement memorandum (PPM) is a crucial legal document for companies seeking to raise capital through a private equity offering. It provides investors with detailed information about the company, its investment terms, and potential risks. While a private placement memorandum template can provide a starting point, it is essential to consult with legal and business experts to ensure the PPM complies with regulations and effectively presents the company’s investment opportunity. By carefully crafting your PPM, you can attract qualified investors and successfully raise the necessary funds for growth.

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