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, crowd funding 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?
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 three distinct offerings provided under Regulation D. Each of the three offerings is controlled by a rule: Rule 504, 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 crowd funding site such as Equity Net, 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.
Anti-Fraud Rules
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.
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?
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.
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. Be sure to ask the person preparing your PPM what exemption or exemptions you’re offering should fit into and what facts and regulations s/he has analyzed in making that determination. Ask whether she/he will be drafting industry- and company-specific risk factors for you), or if the PPM will only include boilerplate risk factors. And be sure to ask if she/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.
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 Templates are available in the $1,000 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.
Call A Securities Lawyer
If you want to be able to sleep at night and not waste your money, your best bet is to retain PPM LAWYERS 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. As a result, it is the very first layer of defense against potential allegations of securities fraud. Nearly any private placement offering or crowd funding offering cannot go without one as a core best practice.
The Form 1A document standard drives fully registered offerings which are vetted and approved by the SEC and accordingly offers potential investors substantial detail and disclosure. By drafting our clients’ private placement memoranda to Form 1A standards, we strive to maximize clarity, efficacy, and liability insulation. Moreover, drafting PPM’s to this standard enhances the offering’s viability among investors, financial advisors, placement agents, as well as institutions. Finally, our services include taking our robust private placement memoranda and enhancing their presentation value with the highest level graphics and visual content. While a PPM is the heart of a private offering, there are many other considerations and decision points that require a skilled and experienced hand. In particular, the actual structure of the offering (as a small sample: debt versus equity, waterfall mechanics, pro formas, conversion mechanics, investor rights, etc.) is not something that should be randomly chosen. An Attorney provides comprehensive planning, strategy and consulting services in and around your offering to assure optimal structure. Moreover, he can quickly and modify aspects of the offering as each deal often evolves over a period of time and as individual investors request particular incentives and rewards for investment.
A brief summary of those considerations are below, any of which can have drastic implications for the overall character of the private placement offering:
• Pre Offering Analysis and Consultation: Analyzing the venture prior to designing the offering structure so as to identify and offset major weaknesses in the venture itself that may undermine investment viability is a key step.
• Debt versus Equity: One of the primary concerns for any private placement offering is the actual “security” to be offered. Contrary to popular belief, one can sell debt security as well as equity (i.e., the difference between an investor actually owning pieces of the company, versus the investor owning an obligation to pay back a debt). Since this is a major strategy point careful consideration has to be given to the various pros and cons of both approaches, which can have far-reaching implications.
• Optimally Choosing from Various SEC Exemption Rules: There are various “flavors” of private placement offering exemptions that each have their own set of pros and cons (e.g., the total amount of the capital raise, the nature of the documents required for prospective investors, etc.). Properly navigating between them so as to optimize the options and minimize the requirements of the issuer is a key strategy point and requires careful planning.
• “Blue Sky” Filing Strategy and Implementation: All private placement offerings have a double government footprint–a state footprint based on the residence of each investor, as well as the federal footprint which applies across the board. As a result, private placement offerings generally require notification filings (i.e., forms that indicate the nature of the offering, the principals involved, etc.) to be made with these states as well as the federal government. Each state has its own set of requirements which can add complexity and costs. Properly navigating between them so as to optimize the options and minimize the requirements of the issuer is a key strategy point and requires careful planning.
• Share and Unit Classes and Rights: An issuer cannot simply sell “shares”, without considering what investor rights, duties, and obligations attach to each (information rights, management rights, payout preference, etc.). As a result, while pricing the shares or notes is also key, special care should also be given to the various classes the shares, notes, etc. can take since that will dictate many of these rights, duties, and obligations (e.g., common, preferred, or convertible preferred equity).
• Engineering the Capitalization Structure: Properly devising the company capitalization structure (how many shares makes sense given both current and future capitalization/growth needs, company valuation and share, etc.) requires careful planning. Using figures that do not factor in long term considerations can potentially harm the company’s growth and deter investment in the current offering.
• Min/Max Offering: In certain cases, an issuer may be required by statute to or may desire to set a minimum threshold of investment that must be met prior to releasing or being able to utilize the funds. This is a tricky consideration and must be planned with care, so as not to unduly hamper the offering with over onerous thresholds, while still satisfying investor and statutory requirements.
• Engineering Investor Returns and Waterfalls: At the heart of any offering is the actual model of return for an investor. Each offering is different in terms of incentives, industry norms, participants, and a variety of other factors that may affect these models. In addition, a venture or project may leverage a jigsaw puzzle of funding sources including private equity or debt and institutional sources that may also affect this model.
• Marketing Strategies: Any private placement offering should be generated with a robust understanding of the optimal strategy to market that offering based on a solid sensitivity to the investor audience. In addition, after the offering has been generated.
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