When you are raising money, disclosure is your friend. If you tell an investor about a risk and that risk then causes the investment to not pan out as planned, you can point to that disclosure (assuming it is in writing) and say to the investor, “Look, I told you this might happen.” Disclosure helps prevent fraud claims; an investor cannot say that he was defrauded when you have a written and adequate disclosure that says such might happen. So, how do you make such disclosures to investors?
In the process of raising funds, there are very few things with respect to written material which are “standard” despite a good deal of commentary about this type of document being standard. Investments conversations usually begin orally and then develop from there. Sometimes companies will have a “pitch book” or “deck,” which is jargon for a Powerpoint presentation that they will show to potential investors;1 maybe instead of a pitch book, it may be an executive summary.
Depending on whether the conversations develop, the investor will ask “Do you have a PPM?” or the entrepreneur will give “more documents.” As the relationship is beginning to progress from initial cursory conversations to more detailed nuts and bolts about the investment, the need for a document that fully explains the investment becomes apparent.
A private placement memorandum (PPM) is a document which contains relevant disclosures so that the investor can weigh the risk involved with an investment and make a fully informed decision with respect to the investment. A formal private placement memorandum is designed to meet the disclosure requirements of Rule 502(b)(2) of Reg D. While these apply only to certain types of investments which have non-accredited investors, almost all private investments where you solicit more than a handful of investors are going to need some form of disclosure documents. “Confidential Information Memorandum” or “Disclosure Document” or some variation of these terms are usually essentially PPMs.
The cost and complexity of providing one of these documents is not insignificant. Although there are usually some boxes that need to be checked in terms of disclosure items, PPMs typically do not have a standard form. They are very deal specific, as the focus is on disclosing relevant information applicable to a specific company. Financial, accounting and legal legwork is required to develop a strong PPM, and while checking the legal requirements is important, this document is a company putting its best foot forward with respect to investors; a PPM has to be professional. I generally estimate the cost to be $20,000 for a good PPM.2 PPMs need to be good crisp documents, adequately explaining the business and the business risk, giving the financial picture in an accurate assessment and providing the necessary legal disclosure. Additionally, the process itself has to be managed. A general ban on solicitations and the confidential and proprietary nature of many PPMs requires the number and recipients of PPMs to be controlled. More importantly, getting people to invest requires a good deal of effort and management.
With this amount of cost, I am often asked, “When do I need to get a PPM?” and indeed this is a crucial question. This is also a tough question and has a little bit of a chicken or egg element — in order to get the money, you need the PPM, but in order to get the PPM, you need the money. I believe business people raising capital should have a strong sense of the capital markets and the ability to close the deal. Generally, I believe it is a good idea to have at least half of the money raised in hard commitments. A hard commitment is a just a short wrung shy of a legally-binding commitment. A hard commitment is not buying someone a drink at a bar and getting a commitment from him or her. To get hard commitments, particularly without a PPM, requires familiarity and trust with both you and the business.
That said, in order to get to a signed document and a check, you need to have an investor feel comfortable, and a PPM in certain situations is often instrumental in that progress. Disclosure also protects the company from later fraud claims. A PPM will usually contain the agreements (or at least a proposed agreement) necessary to consummate a transaction. A PPM signals to investors that you are serious in the process and contains a targeted timeline for closing. Thus the importance cannot be understated.
Goodrich Law Firm, LLC
1 Somewhere in that deck is a slide that shows how the investment will make a one thousand percent return for the investor. As opposed to the cleansing disclosure document, I refer to this slide as the rope upon which an entrepreneur is later hanged.
2 This is what I call a gross professional estimate, which is to say somebody who knows what they are doing and could charge for their services would charge for this amount. In order to do this, legal, finance, accounting, business strategic needs to combine as well as both high (professional) and low (clerical) input is necessary. People combine to do this and the more efficient you are in building the team the better. However, you need to focus on the fact that one person, profession or skill level can, or should not, do everything.