Giving Investors Information: The PPM
Andrew J. Sherman, Partner, Dickstein Shapiro Morin and Oshinsky LLP
The Private Placement Memorandum (PPM) consists of legal documents and exhibits given to potential investors when a company is issuing securities exempt from federal registration and filing requirements, as described in last week's column on "Private Placement Offerings." The PPM describes the background of the company, the risks to the investor and the terms of the securities being sold.
Several factors affect the type of information that must be provided and the format in which the data are presented, including:
- minimum level of disclosure that must be made under federal securities laws (which depends, in part, on which exemption from registration is being used)
- minimum level of disclosure that must be made under an applicable state's securities laws (according to the state or states in which the securities are being offered or sold)
- sophistication and expectations of the targeted investors (some investors will expect a certain amount of information presented in a specified format, regardless of what the law may require)
- complexity or nature of the company and terms of the offering. Many companies should prepare detailed disclosure documents (regardless of whether or not they are required to do so) in order to avoid liability for misstatements, fraud or confusion, especially if the nature of the company and/or the terms of its offering are very complex.
Each transaction or proposed offering of securities must be carefully reviewed by legal counsel to determine, first, the minimum level of disclosure that must be provided to prospective investors under applicable federal and state laws. The costs of preparing a more detailed document than may be required should be weighed against the benefits of the additional protection provided to the company by a more comprehensive prospectus. The key question will always be, "What is the most cost-effective vehicle for providing the targeted investors with the information they require and that both applicable law and prudence dictate they must have?" There are no easy answers.
The specific disclosure items to be included in the PPM will vary, depending on the size of the offering and nature of the investors under federal securities laws and any applicable state laws. The text should be descriptive, not persuasive, and allow the reader to reach his or her own conclusions as to the merits of the securities being offered by the company. Use the following as a checklist in preparing your PPM.
The opening pages lay out the basic terms of the offering. A cover page should include a brief statement about the company and its core business, the terms of the offering (often in table form) and all required "legends" required by federal and state laws. This should be followed by a summary, which serves as a cross�reference for the reader. The third and final part is usually a statement of the investor suitability standards, including a discussion of applicable federal and state securities laws and the definitions of an accredited investor as applied to this offering.
Description of the Company
This section gives the company's history (as well as that of its affiliates and predecessors) and describes its principal officers and directors, products and services, management and operating policies, performance history and goals, competition and trends in the industry, advertising and marketing strategy, suppliers and distributors, intellectual property, key real and personal property, customer demographics and any other material information that would be relevant to the investor.
This is usually the most difficult section to write, yet it's viewed by many as one of the most important to the prospective investor. Its purpose is to outline all the factors that make the offering or the projected business plans risky or speculative. Naturally, the exact risks to the investors posed by the offering will depend on the nature of the company and the trends within that industry.
Capitalization of the Issuer
The capital structure of the company, both before and after the offering, should be explained here. For the purposes of this section in the PPM, all authorized and outstanding securities must be disclosed (including all long-term debt).
Management of the Company
Include in this section a list of the names, ages, special skills or characteristics and biographical information on each officer, director or key consultant; compensation and stock option arrangements; bonus plans; special contracts or arrangements; and any transactions between the company and individual officers and directors (including loans, self�dealing and related types of transactions). The role and identity of the company's legal and accounting firms, as well as of any other expert retained in connection with the offering, should also be disclosed.
Terms of the Offering
The terms and structure of the offering should be based on a series of preliminary and informal meetings with possible investors, as well as on research on current market conditions and recently closed, similarly situated offerings. They are described in this section, along with the number of shares and the price. If the securities are to be offered through underwriters, brokers or dealers (to the extent permitted by federal and state laws), then the names of each distributor must be disclosed, as well as (1) the terms and nature of the relationship between the issuer and each party, (2) the commissions to be paid, (3) the obligations of the distributor (e.g., guaranteed or best efforts offering) and (4) any special rights, such as the right of a particular underwriter to serve on the board of directors, plus any indemnification provisions or other material terms of the offering.
Allocation of Proceeds
Here you must state the principal purposes for which the net proceeds will be used and the approximate amount intended to be used for each purpose. Give careful thought to this section, because any material deviation from the use of these funds as described in the PPM could trigger liability. If no exact breakdown has been prepared, then try to describe why additional capital is being raised and what business objectives are expected to be pursued with the proceeds.
This section discusses the number of shares outstanding prior to the offering, the price paid, the net book value and the effect of the proposed offering on existing shareholders, as well as its diluting effects on new purchasers' shares at the completion of the offering. Often the founding shareholders (and sometimes their key advisors or the people who will help promote the PPM) will have acquired their securities at prices substantially below those in the prospective offering. As a result, the book value of shares purchased pursuant to the offering will be substantially diluted.
Description of Securities
The rights, restrictions and special features of the securities being offered should be explained in this section, along with any applicable provision of the articles of incorporation or by-laws that affect the company's capitalization (such as pre-emptive rights, total authorized stock, different classes of shares or restrictions on declaration and distribution of dividends).
What statements the issuer has to provide will vary according to the amount of money to be raised, applicable federal and state regulations and the company's nature and stage of growth. Provide a discussion and explanation of these financial statements and an analysis of the company's current and projected financial condition.
Documents such as the articles of incorporation and by-laws, key contracts or leases, brochures, news articles, marketing reports and resumes of the principals, may be appended as exhibits to the PPM. These documents are usually examined by attorneys and accountants during the due-diligence process.
Once the prospective investors and their advisors have decided to provide capital to the company in accordance with the terms of the PPM, there is a series of documents that must be signed to demonstrate the investors' desire to "subscribe" to purchase the securities offered by the PPM. Subscription materials serve several purposes. The two key documents are:
Offeree and/or Purchaser Questionnaire. Developed to obtain certain information from prospective investors, this document then serves as evidence of their required sophistication level as required in a PPM. You may also wish to attempt to obtain information regarding the prospective purchaser's background, citizenship, education, employment, investment and/or business experience.
Subscription Agreement. This is the contract between the purchaser (investor) and the issuer for the purchase of the securities. It should contain acknowledgments of the purchaser's receipt and review of the information given about the offering and the issuer; the restricted nature of the securities and the fact that the securities were acquired under an exemption from registration; any particularly significant suitability requirements (such as amount of investment or passive income, tax bracket, and so forth) which the issuer feels may be crucial to the purchaser's ability to obtain the benefits of the proposed investment; an awareness of specific risks disclosed in the information furnished; and the status of the purchaser representative (if one is used).
The Subscription Agreement should also contain the purchaser's reconfirmation of the accuracy and completeness of the information contained in the questionnaire; the number and price of the securities to be purchased and the manner of payment; and agreement to any special elections that may be contemplated (such as "S" corporation elections, accounting methods and any relevant tax elections). The Subscription Agreement often contains an agreement on the part of the purchaser to indemnify the issuer against losses or liabilities resulting from any misrepresentations by the prospective purchaser that would void or destroy the exemption from registration that the issuer is attempting to invoke.