Small private companies raise funds without going public from selected investors using a Private Placement Memorandum or PPM. A PPM allows companies to get investment for their business without actually having to register their stock with the Securities and Exchange Commission or SEC to the same extent as a public company.
When businesses are seeking investors, they usually have two options. They can either seek funding from the general public by offering shares or bonds, or they can reach out to a specific group of individuals to seek out investment.
PPMs are gaining popularity because they can help legalize private placements and give selected individuals the complete information that may compel them to invest in a company. Private placements can be used by startups or companies that are in the early growth stages and need investors to help them grow faster.
However, since a private placement memorandum is not as commonly used as a business plan or other investment tools, a lot of investors and startup owners aren’t sure what they are. Not to mention, a PPM can only be used in certain situations and it is not applicable for every company.
So if you are wondering what a PPM is, what it contains, its applications then we suggest you keep reading.
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What is a private placement memorandum?
Before we move on to other details about a private placement memorandum, it is important to have a deep understanding of what this memorandum is all about.
A private placement memorandum is also referred to as an offering memorandum, and it is exclusively used for private transactions. When drafting a private placement memorandum you should include a description of the company, the terms and conditions of the private offering, risks associated with the investment, financial performance, and the future forecast of the business.
Again, all the information provided in a PPM will need to be verifiable and the tone of the document shouldn’t be persuasive, but factual. Instead, the PPM should provide key details to investors, so they can make a sound investment decision.
With that said, a PPM may also serve some marketing purpose if it is drafted professionally and contains everything the investors want to know. While the focus will still be on providing as much factual data about the company as possible, it can also contain some marketing elements that can help sell the private offering to investors.
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Private placement memorandums versus a business plan
In short, a PPM is close to a business plan in terms of its application. However, while a business plan focuses on the marketing aspect of a business and aims to promote the business, a private placement memorandum focuses on providing factual information about the company.
Not to mention, a business plan can be distributed among the public. However, a PPM is only made accessible to a select number of potential investors. These are just some basic differences between a PPM and a business plan, and here is a list of major features of both a PPM and a business plan to help differentiate between the two:
Key features of a business plan
The key features of a business plan include, but aren’t limited to:
- A quick summary of what the business is about and what are the future goals.
- How the business creates value for customers, the USP (unique selling point), and what problems the business solves.
- A comprehensive marketing plan that tells potential investors about the marketing strategy as well as:
- The key competitors of the business
- Target market
- The condition of the market
- Financial details of the business
A plan of action that describes how you plan on approaching your target market and how you are going to capture a market share to generate revenue
Key features of a private placement memorandum
The key features of a private placement memorandum include, but aren’t limited to:
- A description of what you are offering to investors e.g. capital, equity, or securities. This description is known as Terms of the Offering
- Disclosures about any SEC, federal, or state laws that regulate the private offering
- Information about the type of securities being offered
- The risk factor of investing in the company
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What are the key components of a private placement memorandum?
A private placement memorandum should be drafted as professionally as possible to make sure it fulfills all the legal requirements. Not to mention, it should be complete and contain all the information the potential investors might need to make the investment decision and evaluate the risks associated with the investment. With that being said, here are some important components of a PPM that you should know about when drafting one for your private offering.
The executive summary is meant to get the investors interested in the investment opportunity being offered. So while the executive summary should contain a summary of the PPM, it should also highlight key information from the PPM that can pique the investor’s interest.
The overview section is going to introduce your organization to the investors, including what your organization does, and what you plan on doing with the investment once you receive it.
This section can be used to show investors that you have done your homework by showing SWOT analysis for your company, the market knowledge of your team, and how you want to improve your business over time.
Terms and conditions
Just like any other investment document, a PPM contains a terms and conditions section that will govern how the deal will be structured, voting rights, liquidation rights, and information rights. This section requires special care when drafting, and it is best to hire a professional attorney to help review the terms and conditions of your private placement memorandum.
The risk factor section in a PPM is the most important section of the document from the investor’s point of view. When you are drafting a PPM, you should carefully list down potential risks associated with investing in the company.
This section is added near the start of the PPM so that the investors can be made aware of the potential risks associated with investing in your business early on. The risk factors section should also be drafted with the help of legal experts to make sure it doesn’t miss any important risk factors, as required by regulators.
The financial statements section offers business owners another way to tell potential investors about why their business can be a sound investment for them. In the financial statements section, you will want to add financial details that show how the business has been performing in the past.
This section will be used by investors as a benchmark to analyze if your business is a good investment and whether it has the potential for further growth. The financial statement section can be completed by the company accounting firm, as they usually have the financial statements that need to be used in this section.
Use of proceeds
While you might have added a short description of how you plan on using the proceeds from the investment in the overview section, the use of proceeds section will explain this information in detail. As a private issuer, you have to convince the investors that you have a plan for how the investment is going to be put to use.
Since a business requires investment to run various functions, it is best to list down each category and how much funds will be allocated for each function of the business.
These are some important sections that should be added to a PPM to make it useful for the investor, as well as keeping the issuance of private stock within the legal jurisdiction. Other sections may be added to the PPM to make it more detailed or to comply with specific rules and regulations.
When to use a private placement memorandum?
A private placement memorandum is a useful document. However, it may not be necessary for every single fundraising campaign. With that said, here are some scenarios where a private placement memorandum can be used:
- When you are about to launch a startup and need to raise funds in order to cover the launch expenses
- If your offerings are worth more than $5 million, and you seek investment from non-accredited investors
- You want to solicit funds from the public
- If you are seeking investment from angel investors and want to use a formal approach when reaching out to them
- If you want to negotiate with a group of investors regarding investing in your firm on fixed terms.
In short, a PPM may be useful to you if you are seeking investment from a small group of investors, and you are a growing operation.
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Advantages and disadvantages of a private placement?
While private placement is a great way to raise funds in some situations and has its advantages, it is also important to mention that private placements also come with some disadvantages. Here is a list of all the advantages and disadvantages of a private placement.
Advantages of a private placement:
Lower cost: Public placement comes with high costs, including a registration fee and an advertisement fee. However, private placement can have lower costs associated with it.
- Simpler regulations: When you use private placement as a mode to raise funds for your business, you have to comply with fewer regulations compared to when using public placement.
- Potential of reaching the right investors: Since private placement involves reaching out to a selected group of investors, the chances of finding the right investor for your business increase significantly.
- Privacy: Since your business information is only disclosed to a few selected investors, your company information remains confidential, thus maintaining the privacy of your company data.
- Faster investment: Private placement usually yields investment quicker, as there aren’t any complicated steps involved in a private placement.
Disadvantages of a private placement:
- Reduced number of investors: If you choose to use private placement as your funding method, you restrict yourself to a selected group of investors. This means you may end up putting in more effort to get the required investment to fund your business.
- Investor expectations: Private investments are trickier, not to mention riskier compared to public investments. So it is obvious that the investors may expect a higher return on their investment to make up for the risk that they are taking by investing privately.
- Lower rates: As mentioned earlier, private investments are considered riskier, which means securities issues in a private placement may sell for a lower rate. So, not only is it difficult to find investors who are willing to take the risk by investing privately, but the investors may also expect to buy the securities at a lower rate.
A private placement memorandum is definitely one of the most important parts of private placement transactions. Not only is it a legal requirement that needs to be fulfilled for legalizing a private placement, but it also helps keep the transaction in order.
So if you were planning on seeking private placement investors but didn’t know where to start, this article should help. Though it is always wise to leverage your marketing team for copy, advisors, and legal counsel.
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