With the number of regulations governing the securities market, private and public offerings, with their private placement memorandums (PPM), carry a certain degree of difficulty to master. There’s a learning curve regarding everything from finding investors, identifying lucrative deals, and navigating the legal environment.
Real estate syndication is no different in this regard and, in some cases, may even be more confusing to new syndicators.
It’s an investment vehicle known for the many exemptions it can enjoy when following the right procedures.
This article will focus on one area of real estate syndications that seems complex on the surface but isn’t that complicated once you do some research – the private placement memorandum.
So, let’s dive into what you must understand to increase your chances of pulling off profitable syndication deals.
Do you or don’t you need a PPM?
Real Estate Syndication Deals 101
Before jumping into the concept of a private placement memorandum, let’s clarify a couple of things. First of all, it’s essential to understand a real estate syndication.
What is it?
In simplest terms, a real estate syndication is an investment vehicle in which a group of investors combines their capital to buy a large income-generating property. In most cases, syndications are created to allow investors to acquire properties much more expensive than either of them could afford to buy on their own.
Real estate syndications are often confused with real estate funds. However, there are key differences between these structures. For one, in syndicated deals, investors pool their resources to fund the purchase of already identified properties, residential or commercial.
In contrast, a private equity fund forces investors to fund deals blindly, relying only on the reputation and vision of the sponsor or equity issuing company. Therefore, syndications are more flexible and convenient for both sponsors (syndicators) and investors.
The blind capital investment nature of funds makes it more difficult to raise money, as not all investors prefer the “trust-me” nature of these financial instruments. Furthermore, a real estate syndication deal can be structured in many ways and allow more leeway regarding the property asset’s hold period.
Now, to set the tone for the PPM discussion, you need some context on the parties involved in syndication deals and the roles of different members.
A real estate syndication starts with the sponsor, syndicator, or general partner. This is the individual or company with real estate experience and the capabilities required to identify properties, underwrite, and complete due diligence reports.
Next, you have your limited partners or passive investors. These can be accredited or non-accredited investors, depending on what Regulation D exemption you want to present your private placement offering. Limited partners often put up the majority of the capital necessary to fund the purchase and receive a percentage stake in return, along with a distribution of profits from cash flow and liquidation deals.
The Role of a Sponsor
Identifying profitable properties, performing due diligence, and reaching out to investors are among the most important tasks a syndication sponsor has to undertake. However, let’s look at it from an investor’s perspective.
What does an investor expect from a sponsor, or general partner, to be inclined to fund a capital raising event?
Similar to how syndicators should try to find the right investors, companies or high net worth individuals need to find the right sponsor. Real estate syndication is a highly competitive playing field where there’s no shortage of offers.
So, what do investors want?
First of all, they expect the syndicator to do a good job of flying the plane. General partners are not responsible only for raising capital and finding properties. They also undertake the daily operational management responsibilities necessary to ensure stable cash flow, asset appreciation, and so on.
Secondly, private placements are heavily regulated by state and federal laws. The Securities and Exchange Commission (SEC) created and enforced various regulations in the private offering market to protect investors. This is achieved through a series of laws introduced by the Securities Act of 1933, enacted during the Great Depression, and its many modifications over time.
Although the Act saw several changes over the years, many with the sole intent of loosening regulations, regulatory bodies, and authorities still watch the private placement market.
That makes investors look for sponsors that do their due diligence not just on income-generating real estate assets but also in terms of any regulations governing the offering, such as state and federal mandates.
This often comes down to two things:
- Understanding securities laws
- Drafting the necessary paperwork
Documentation includes things like deal structure, projected returns, capital structure, management plans, manager fees, risks, and other vital topics.
Remember that private placement offerings under Regulation D typically make a syndicator’s job easier. Qualifying for exemptions is not as tricky as registering an IPO, creating a REIT, or dealing with other real estate investment vehicles that often take the general public solicitation route.
That said, the regulations were created to safeguard investors against fraudulent or misleading claims of value and profitability. These same laws designed to protect investors have also made it difficult for startups and syndication companies to raise money.
Once the exemptions were introduced and the regulations for private placements got loosened, securities issuers were given new opportunities to fund their deal deals.
But while this may seem like excellent news to a syndicator such as yourself, here’s what you need to understand. Placing a private offering through Regulation D might be easier than going public.
You’re not even obligated to register or file extensive paperwork to go through with a deal.
Nevertheless, you’ll need money to finalize the deal, which means onboarding a certain number of investors. So, presenting prospective investors with a private placement memorandum is essential to funding your capital raising event, even if you’re not legally bound to do it.
To recognize the importance of this document, let’s go over the basics, topics covered, and how it benefits you to pass it out to investors.
Understanding the Private Placement Memorandum (PPM)
What is a private placement memorandum? As described by the SEC, the PPM is a legal document. Its goal is to inform investors of material facts and disclosures regarding the sale of securities in a private placement offering. This case deals with facts regarding a real estate syndication that may influence the investor’s decision to agree or disagree with the terms of a deal.
In regards to the framework and scope, the PPM is very similar to a prospectus summary given during public offerings, such as the creation of real estate mutual funds.
A PPM isn’t reviewed by federal or state governing bodies. Instead, investors review it to determine the potential of an investment opportunity on the private placement market. Therefore, its contents must include everything an investor needs to know to make a fully-informed decision.
Why You Need It
Qualifying for an SEC Reg D exemption under rules 504, 506(b), or 506(c) isn’t dependent on whether you create this documentation. The whole idea of turning to private offerings to raise capital is that it’s supposed to be easier – a shortcut, if you will, for syndicators to get the funds, they need to finalize their deals.
However, even investors that aren’t knowledgeable about securities laws understand why they exist. Without these blue sky laws and federal regulations, securities issuers could reel investors in with false promises without any accountability or risk of being held liable.
Therefore, private investors want to do their due diligence too and fully understand who they’re trusting with their money.
You can really look at a PPM document in many ways. It can serve as a detailed background check into your business and personal track record. It can provide a due diligence report on the industry itself, which many of your potential investors are likely unfamiliar with on many levels.
In one way, a PPM is also a marketing tool since it can contain elements of your business plan. Thus it can highlight cash flow projections, appreciation forecasts, market trends, and other elements that investors may need to know before making an informed decision.
No matter how you look at it, it’s a lengthy document.
You’re not legally obligated to produce the PPM paperwork to create a private placement offering and sell equity. But your ability to do these things, as well as getting enough investors interested, may rest solely on the contents of your PPM.
Another thing worth adding here is that a PPM isn’t used only in real estate syndications. You’ll also find it in crowdfunding, real estate investment funds, and private real estate investment trusts. Any type of private placement offering is likely accompanied by a deal-specific PPM document that clarifies the nature of the deal to potential investors.
PPMs vs. Business Plans and Term Sheets
In many cases, a PPM can run to dozens of pages. Because of its length and very broad nature that covers a wide range of topics, it’s often confused for other types of documents.
For example, some syndicators, and even investors, may confuse a PPM for a business plan. Why?
There is considerable overlap in sections or chapters. However, there’s a key difference between the two documents. A business plan doesn’t necessarily focus on disclosure. Its primary intent is to convince potential investors to fund a capital raising event.
Therefore, it emphasizes things such as market trends, projected profits, financials, management strategies, and other topics in a favorable light.
The PPM contains much, if not all, of these things while adding more material facts and relevant information.
A term sheet is another rarely binding document that serves mainly as a letter of intent. It contains relevant terms of the investment that help investors decide if they want to learn more about the offering.
Typically, once an investor signs a term sheet, they only commit to starting the legal and due diligence process. That triggers the issuer’s real estate syndication attorney to draft financing documents.
Of course, depending on the structure and specific type of deal, a term sheet can feature legally-binding provisions – confidentiality, jurisdiction, dispute resolution, reimbursements, and other elements of this nature.
PPM Key Topics
As mentioned above, a PPM is almost always a lengthy document covering a wide range of topics about the industry, syndicator or issuing company, and the offering. But some topics of conversation interest investors more than others.
Let’s go over some of the content in the PPM that investors rely on to carry out their due diligence of the private placement offering.
What should you address in the risks and challenges section of the PPM? Federal securities laws mandate that when informing investors of the terms of an offering, you must offer full disclosure regarding risks.
Investors need to understand all possible disadvantages to formulate an informed decision to fund or reject your offering. Therefore, many of the risk factors will be specific to your business.
As such, you’ll want to indicate the many reasons that could cause your business to fail and lose your investors’ money.
- Not enough management experience
- No operating history
- Recent drops in profitability
- Poor financial position
- Strong market competition
- Taxation and legal issues
From there, the risk section should also address the challenges and disadvantages of the real estate industry. As with any venture, some unfavorable situations are out of your control and can come up at an unforeseen moment.
For example, natural disasters, an economic crash, wars, health crises, and other things can affect the profitability of your private offering. Investors have to be made aware of these things for two reasons.
Firstly, they have to fully understand the risks involved. Secondly, they need to realize that you can’t be held liable for matters that are out of your hands.
Then, you can emphasize offering specific risk factors such as increased renovation costs, mainly in Class B and Class C-type properties. Lack of market interest or community development in the area surrounding the property in question.
There could also be various taxation issues pertaining strictly to your proposed deal, on top of any industry-related tax regulations and exemptions.
Syndicator and Management Information
Especially when dealing with non-accredited investors, you’ll often have to provide extensive background information about yourself and your business. By definition, non-accredited investors are considered less wealthy and sophisticated than accredited investors. Hence, state and federal laws mandate that securities issuers exercise extra attention to detail when issuing a private placement offering.
So, you have to provide a detailed description of your business, vision, mission statement, and unique value proposition. You should clarify marketing strategies, inform investors of your capital and other assets you hold.
It’s also vital to provide information regarding pending litigations against your business and a list of bad actor events.
Of course, it’s rare for syndicators to work alone on these deals. Managing large commercial and residential real estate properties is a full-time job. If you want to focus on putting deals together and growing your property portfolio, someone else has to take over daily operations management tasks.
Therefore, you should have full disclosure regarding your internal management team, employees, other partners, or third-party businesses that will be involved with the offering moving forward.
No investor will fund your private placement equity offering if they don’t understand how you plan to distribute the profits. After all, you’re promising a substantial return on investment, often higher than the market average.
Consider that while some passive investors can make between 3.5% and 8% per year in dividends, private placement investors expect a much higher return from syndication deals. These deals attract potential high net worth individuals with returns upwards of 15% or 20% during the term of the deal, with extra incentives such as steady cash flow distribution and another chunk of money upon the dilution or liquidation of the income-generating asset.
Your PPM should clearly explain how much your investors will receive based on their share of the equity. Of course, you can go deep into details about payment terms, return thresholds, waterfall structured splits, etc.
The more detailed this section is, the easier it will be to clarify the profitability of your investment proposition.
And let’s bring this back to the two primary reasons you need a PPM – allowing investors to do their due diligence and convincing them to fund your offering.
The profit distribution plan section is clearly a double-purpose element. It’s an opportunity to get potential investors engaged and more excited about your proposition.
Did you know that not all investors in the private sector know if they’re able to fund a capital raising event?
The SEC has clear definitions for who qualifies as an accredited or non-accredited investor. Your PPM should clearly outline the criteria investors must meet to put money into your deal. Depending on what Regulation D exemptions you want to benefit from, you may only work with one type of investor.
So, the PPM tells investors if they fit the correct profile or not, thus avoiding wasted time on both sides of the table.
In any transaction involving securities, debt, or equity, you may run into conflicts of interest. With real estate syndication deals, this happens more often than you realize, especially once you start building a massive asset portfolio.
Your employees, partners, past investors, and other parties involved with your business may spark conflicts of interest with your new private placement offering. Therefore, you have to identify these conflicts and disclose them to investors.
3 Essential Functions of a PPM
Why do you need a private placement memorandum? The Private Placement Memorandum (PPM) contains all the information about securities offered to investors, including risk factors and investment objectives. It also contains other important details like how proceeds will be used by the real estate syndication company, projections, the Operating Agreement, as well as to provide them with details of the proposed project such as location, real estate company’s business plan, etc. It serves as a shield against damages from any real estate investment claims.
The private placement memorandum makes disclosures and disclaimers to investors (acts as a shield)
A private placement memorandum is a document that contains all the essential information about real estate investment. The real estate company can use it as a shield against real estate investment risks. The real estate company can use PPM to provide investors with details about real estate projects. The real estate syndicators and real estate investment trusts (REITs) also use the document to disclose all information that investors need to know, including risk factors and investor objectives.
The real estate syndication PPM is a document prepared by an attorney for real estate investments. Unlike prospectuses used for real estate investment, the real estate syndication PPM is not regulated by the Securities and Exchange Commission (SEC). It contains information about how the real estate syndication company or real estate project will use funds from offering to real estate investors.
A private placement memorandum usually consists of elements like the real estate project description and summary, risk factors, real estate syndication company information, real estate acquisition plan discussion, real estate development term sheet, real estate taxation issues, legal opinion, and real property.
The PPM explains the Operating Agreement of a syndication
A private placement memorandum (PPM) explains the real estate syndication’s Operating Agreement. The real estate syndication’s Operating Agreement is a legal document. The real estate syndication’s private agreement between the real estate syndication members contains all the rules about how to manage the real estate syndication, who gets what when, what happens when someone dies or retires, etc. The real estate syndication’s Operating Agreement does not have to be registered in any particular state for it to be enforceable, but it can be used in court as evidence.
The private placement memorandum tells investors it is a good investment
One of the most critical functions of a private placement memorandum is to make an investor believe that it is a good investment. A real estate syndicator will typically neglect to do this. A well-drafted PPM does something that real estate syndicators usually miss: it persuades the investor that the real estate investment is worth investing in.
The PPM is used to get investors interested in investing in a new development project. It tells them all about the property (location, structure, price per square foot), it explains how their money will be spent (land appraisal, closing costs etc.), and it tells them all about the real estate developers. The real estate developer or realtor then uses their own private placement memorandum when they are meeting with real estate investors, real estate analysts, real estate agents, etc. They give this private placement memorandum to interested parties to get them to sign a contract for purchasers.
When reviewing, it must look right (no fancy pictures), but it certainly can act to pitch investors again on why they said they were interested in the first place. Many potential investors take the PPM to their attorney or account to get feedback. This is an opportunity for a syndicator even to get new investors (the attorney or account themselves), but also, you want their advice to be, “this looks pretty good and clear to me.”
How to get a PPM for your syndication
Real estate syndication attorneys, like Moschetti Law Group, work with real estate developers and real estate agents who have found a piece of property that they want to sell. The attorney drafts the purchase agreement, marketing materials, private placement memorandum, and other documents for this real estate syndication.
The private placement memorandum is a key document in real estate syndication because it makes disclosures and disclaimers to investors, explains the Operating Agreement, and tells investors that this investment opportunity is worth their time.
When You Need a PPM
Syndication offerings can differ in structure. While they may have to conform to state regulations and also benefit from federal or state registration exemptions under Rule 506(b) and Rule 506(c) of Regulation D of the Securities Act of 1933, that’s not always the case.
Here is where having counsel from a syndication attorney can come in handy.
State laws, or blue sky laws, may sometimes override federal securities laws regarding registration and disclosure documentation.
Say your business doesn’t have to register your offering with the SEC, which is the case in most states. However, the Rule you pick matters. For example, if you choose a private placement offering under Rule 504 of Reg D, you might find yourself obligated to register within the state of residence of your potential investors.
This can cause a series of complications, especially when you get investors from multiple states.
So, you might even be legally bound to draft a PPM in some states, depending on the size of your offering, the investors you target, and other factors.
As a good business practice, it’s always best to prepare a PPM for all of your private placement offerings – whether you’re raising funds from accredited, non-accredited, or out-of-state investors.
Of course, a real estate syndication lawyer that prepares private placement memorandums can inform you of any legal obligations regarding the PPM documentation. So, it’s easy to avoid doing unnecessary legwork if you have legal counsel.
That said, it’s very difficult these days to attract investors or make them understand your offering without providing them with ample information on you, your partners, the offering, and the industry as a whole.
You Need a PPM to Raise Capital
The most difficult task of any syndicator is raising private capital for real estate. Sure, securities laws, state and federal guidelines, and other things can create confusion. But you can navigate the legal field if you work with a syndication attorney.
You don’t have to become a legal expert yourself.
With that in mind, being exempted from drafting a PPM or registering your offering doesn’t mean that you should forgo creating and issuing this disclosure document.
Investors want to make informed decisions. They need to understand the risk vs. reward involved in any deal that lands in front of them. The more material facts they can analyze, the more likely they are to invest.
Even if one of your offering isn’t suitable for their portfolios, they might consider looking at other proposals coming from you.
You see, presenting investors with a PPM makes you appear more professional and trustworthy. Investors can see if you have their best interest in mind. If you do, they can become part of your network.
They can follow you and fund multiple deals, thus allowing you to simplify the vetting and due diligence process moving forward.
Simply put, it’s next to impossible to raise capital without a PPM because it’s unlikely you’ll gain a substantial amount of trust and credibility with potential investors.
Besides, a PPM lets you clearly outline the risks and challenges regarding a particular private placement offering. Once investors sign up, you can’t be held liable against things that weren’t your fault, out of your control, etc.
A solid PPM denotes professionalism, ensures regulatory compliance is met, protects against liabilities, and helps raise funds faster from accredited and non-accredited investors.
If you need help with a private placement memorandum, Moschetti Law Group can help. Schedule a free consultation today.
Tilden Moschetti, Esq., is a highly sought-after syndication attorney with nearly two decades of experience. His clientele ranges from real estate developers and startups to established businesses and private equity funds. Tilden’s expertise in syndication law comes not only from his knowledge of syndication and securities law but from real, hands-on experience as an active syndicator himself in every real estate product type and nearly all markets in the US. His knowledge and experience set him apart and established him as the Reg D legal services leader.