Do I Really Need a PPM?
You are an entrepreneur with a fantastic business idea. You have a business plan and you are ready to start raising money!
You may have learned that there are rules and regulations that apply to raising capital for your business. Federal and state securities laws apply whenever you seek capital from investors, regardless of whether they are friends, family, crowdfunding investors, high net worth individuals, angel investors, accredited investors, or otherwise.
A private placement memorandum (PPM), as you may have also learned, is the legal document provided to prospective investors when selling equity or debt in your business. It is sometimes referred to as an offering memorandum or offering document. It provides investors with the information they need as well as protects the company in the event of an investor complaint.
Now you may be asking yourself, do I really need a private placement memorandum? If so, can I write it myself? Can I use a template? Do I need an attorney? And how much do I need to budget for this?
A Little History
The US Federal Securities laws were drafted and enacted primarily as a result of the Great Depression of 1929, in an attempt to avoid a similarly devastating stock market crash from happening again. The spirit of these laws is based on the notion that the Great Depression and the stock market crash of 1929 occurred because companies were selling stock to investors without providing investors with enough accurate and honest information about their companies for that investor to truly make an informed decision about investing.
The Securities Act of 1933 and the Securities Exchange Act of 1934 were enacted to ensure full disclosure was offered by companies whenever they sold stock to investors. In this way, material information would be available and investors would be able to make an informed decision before investing; accordingly, rampant speculation leading to another market crash would be avoided. As time went on, more rules and regulations were added to these initial laws, but by and large, the spirit and letter of these laws have served their purpose quite well over the years.
The overhanging rule behind these federal securities laws is that a company may not sell its securities to investors without first registering with the SEC, unless there is an exemption that applies. The registration process involves providing the SEC with the disclosure of all material information (any information that a reasonable investor would need to know to make a decision about whether or not to invest). The registration process, which is sometimes referred to as an initial public offering (IPO), is lengthy, protracted, and expensive. In fact, it would not be unusual to take 10 months and cost a company $150,000 to conduct a registration. In light of this significant hurdle, the SEC has enacted a number of exemptions to the registration rules that are specifically designed to allow startups and small businesses raise capital more quickly and at much lower cost. Regulation D is one such exemption.
Regulation D Exemption
Regulation D is an exemption that allows companies to raise capital in what is known as a private placement. There are various rules under Regulation D that are designed to allow for different sized offerings. There are four distinct offerings provided under Regulation D. Each of the four offerings is controlled by a rule: Rule 504, Rule 505, Rule 506(b), and Rule 506(c).
The vast majority of offerings are conducted under Rule 506(b) or 506(c). Each allows for the company to raise any amount of money, but differ as follows:
- Rule 506(b). This is a private offering only to investors with whom the company has a pre-existing relationship. Up to a maximum of 35 investors may be unaccredited, but audited financials would be required if there are any unaccredited investors. There is no limit to the amount that can be raised.
- Rule 506(c). This offering allows for general solicitation, which means the company can advertise the offering, list it on their website, use an equity crowdfunding site such as EquityNet, and/or use social media, email, seminars, radio, TV, print, and any other means to market the offering. All investors must be accredited and there are enhanced requirements for qualifying investors. There is no limit to the amount that can be raised.
Regulation D provides entrepreneurs and startups with a truly flexible and lightly regulated means for raising capital. However, raising capital from investors is a securities transaction, and even under Regulation D, and the Anti-Fraud Rules apply. Compliance with these rules is critical to avoid severe civil or even criminal liability, which can include investigation by the SEC, state securities commission, or a State Attorney General, potentially leading to enforcement action. Investors can also pursue civil damages. Rescission – an order to return all funds received to investors – is not an uncommon outcome of such investigations. One purpose of a comprehensive customized PPM is to avoid these outcomes by protecting your company in the event of a complaint.
For a full discussion of the Anti-Fraud Rules, see my blog on Risk Factors and Securities Laws.
Yes, if you want to sleep at night, and avoid devastation in the event an investor decides to make a complaint, then you absolutely need a PPM.
What Are My Options for Getting a PPM?
In my previous post, I described the securities laws pertaining to raising private capital for your company and the importance of a comprehensive and customized PPM. Now that you have decided you want to protect your company by using a PPM, you may be thinking about – or have done some research already on – your options, which include everything from hiring a big law firm to trying to do it yourself.
COSTS: Wide Price Range
There is a significant range in pricing among these options and you may receive price quotes ranging from $2,500 to $35,000. Why the tremendous range in price?
OPTION 1: Large Law Firm
Big law firms have big overhead, including supporting high salaries for associates and partners. The firms will likely charge at least $35,000 to draft a PPM. Keep in mind that only one or two attorneys would be working on your documents, despite the size of the firm, and these lawyers may not even be specialists in private placements, but rather have a more general corporate securities background. These firms may also require an equity interest in your company. Ultimately, the work will probably be good and your interests should be well protected, but the high price tag will choke many startups and entrepreneurs.
PPM LAWYERS focuses exclusively on private placements and provides flat-fee services.
OPTION 2: Non-Attorney Drafter
In your research, you may also come across small firms that offer PPM drafting services for under $5,000. The service providers at these firms are generally not lawyers at all. In this case, the person or people drafting your PPM may have general business experience and will probably model your PPM on a template or sample PPM. If your drafter is not a trained or experienced lawyer, there is a high risk that s/he will miss important nuances and complexities of the federal and state securities laws that apply to your particular business and offering. (See Part I of this blog)
Be sure to ask the person preparing your PPM what exemption or exemptions your offering should fit into and what facts and regulations s/he has analyzed in making that determination. Ask whether s/he will be drafting industry- and company-specific risk factors for you (see my blog on risk factors), or if the PPM will only include boilerplate risk factors. And be sure to ask if s/he will be handling the regulatory filings for both state and federal, as well as what the firm will do in the event an investor complains or has issues with the PPM.
Ultimately, in the case of a non-attorney PPM drafter, you run the risk of getting a final product that does not adequately protect your company and leaves you vulnerable to grave legal exposure and compliance issues.
OPTION 3: Solo Practitioner Attorney/Small Firm
There are also small law firms, sometimes solo practitioners, who will draft a PPM for anywhere from $5,000-$15,000. With such a firm, be sure to find out how much experience the attorney has in corporate securities law in general and PPM practice in particular. Most small firms do not specialize in private placements and may lack the ability to fully understand the nuances of the rules and regulations that apply to your company.
Another consideration with a small firm or solo practitioner is their ability to take calls, discuss your project, and complete your documents within a reasonable time frame. Solo practitioners, in particular, are often overworked and unable to provide focused, personalized service.
It is also important to find out if they are charging you by the hour or with a flat fee. Billable hours have a way of building up to cost prohibitive levels. Find out exactly what you are getting from this lawyer. Will they handle the regulatory filings, and is that included in the cost? Are they drafting custom risk factors that are industry- and company-specific? Are they providing ongoing support or advice throughout the offering, and is that also included in their price quote?
Finally, do your homework on the firm you are considering to ensure that they have a track record of satisfied clients, that you can trust them to complete your PPM in a reasonable time frame, and that they can provide the support you need throughout the process.
PPM LAWYERS focuses exclusively on private placements and provides flat-fee services.
OPTION 4: Doing it Yourself from a Template
PPM Templates are available in the $100 price range. While this low cost is attractive, especially for a startup or small business, consider these factors before you use a PPM template.
- How will you assess whether the template provides a comprehensive structure, includes all necessary components, and reflects the most recent changes in applicable laws and regulations?
- How much time do you have to dedicate to working on your PPM? A comprehensive PPM generally runs 40-50 pages, not including exhibits and appendices. In addition, the language in most templates is likely to be very confusing for a layperson.
- Will the template provider help you? If so, see the “Non-Attorney Drafter” section above.
- Templates are boilerplate documents that have little relevance to your particular business or offering. A good PPM drafter conducts extensive research to ensure that the document is fully customized for your particular business.
- How will you ensure that you’re not making any mistakes with respect to the proper legal exemptions and disclaimers, disclosures, risk factors, securities offering structure, or ownership tables?
Think carefully about these considerations before you spend a lot of time trying to draft your PPM from a template. The answers to these questions are often the difference between a successful raise and a waste of time, let alone the catastrophe of an investor complaint down the road.
Laws and regulations have changed dramatically in recent years and remain in flux; it’s critical that your PPM document reflect the most current state of the law. The complex legal language is difficult to navigate for most people and if you miss something or misinterpret something, you could be putting yourself and your company at risk. Most entrepreneurs will not want to take the risks involved with trying to draft one themselves. Remember, a strong PPM not only impresses investors but also stands as your shield against legal exposure and compliance issues.
If you’re thinking you can draft your PPM yourself from a template and then engage a lawyer to sign off on it, keep in mind that no good lawyer will put his/her name on a document that they can’t stand behind 100%, due to professional liability concerns. If you do find a lawyer who is willing to review your document, it is likely to be at a substantial cost, because careful review of a PPM document is an extensive process. If you are considering this option, you would be wise to first identify a lawyer who is willing to provide the review and find out what they will charge.
If you want to be able to sleep at night and not waste your money, your best bet is to retain an experienced lawyer who specializes in private placements to prepare your documents and provide full coverage and support to you for the entire transaction. Raising capital from investors is not to be taken lightly. Cutting corners at this stage, looking for a cut rate service provider, or spending any money at all to have an inexperienced or unqualified person draft these legal documents is often a waste of money, and can come back to haunt you down the road.