Not a week goes by where I don’t have a consultation with a potential new client who says something along the lines of, “I didn’t do a private placement memorandum in my last three syndications.” It happened last week, and I’m sure it’ll happen this next week as well. Let’s talk about it. Do you really need to use a private placement memorandum? What do I answer these clients? We’re going to go over that.
My name is Tilden Moschetti. I am a syndication attorney for the Moschetti Syndication Law Group. So, do you really need a private placement memorandum? Now granted, I’m biased in this as I prepare private placement memorandums for a living. Let’s go over what exactly a private placement memorandum does first.
The private placement memorandum, or PPM as we’re probably going to call it from now on, is a document which details out the investment itself that’s being made. It details all the risks that are associated with that investment, or at least everyone that we can reasonably think of. We have no way, for example, of predicting that Martians could land on the planet and take over. That’s not one of the risks that we would identify in a private placement memorandum. But we do identify risks such as not knowing what the economy’s going to do in the next year, or what lending rates are going to be and how that will affect our business if they go up substantially.
We also identify that these types of investments are illiquid by nature; we’re not supposed to be freely trading private securities under Regulation D. Those are the kinds of risks that we generally talk about. We also discuss conflicts of interest, like the manager of this fund may have something to gain from it, as they’re going to be receiving management fees. Perhaps it’s a situation where they will make more money by having the investment go on rather than end it when it would make most sense for the investors. We talk about those sorts of inherent conflicts of interest.
We also talk about what the use of the funds is, how the money is getting used. All these things take place in a private placement memorandum.
I like to describe a PPM in this context: It isn’t a marketing piece, it’s not a piece of marketing material that you use to hold up and show the world. That’s more suitable for your marketing materials. The PPM is something else. I like to think of it as when you go to the bank and open up a new checking account, and they give you that big thick booklet that you never look at. You put it back in the folder they gave you and never look at it again. In many senses, that’s what the private placement memorandum is. A lot of people don’t read private placement memorandums.
So why do we still need it? Well, here’s why: First off, you absolutely must have a private placement memorandum if you are doing a Regulation D Rule 506b offering. The chance of a non-accredited investor entering into your investment is very high, and non-accredited investors must get the information that’s within a private placement. It’s critical that they see it, that they have that information. Accredited investors, interestingly enough, aren’t required to see that kind of information.
Now, you may think to yourself, “Well, I’m doing a 506b offering, but I’m only taking in accredited investors. They’ve all told me that.” Well, that bar isn’t really quite right. When we see litigation involving a Regulation D offering, we often see that there are more non-accredited investors than initially thought. We don’t have that issue in a Rule 506c because everybody has to have verification from a third party.
But they still should see this information. Why? Because it answers questions. When the investor calls you up and says, “Well, you never told me that the economy was directly tied to the performance of this investment,” you can show them the PPM and say, “This is where we told you exactly that.” Or when they come to you and say, “You have been paying a preferred return of 7%, but I thought all along that it was 9%,” or “Why didn’t you tell me that distributions are happening annually, not quarterly like I thought they were?” If you don’t do a private placement memorandum, I guarantee you’re going to get those questions.
For the non-accredited investors, we’re talking about a big problem here. You must give them a private placement memorandum. It answers all those questions and goes over all those details. It’s also your backstop at the end of the day. If you ever come under an investigation with the SEC, you can present the PPM and say, “This is what we told them. This is why it’s there. This is what happened.”
So not only is it just a plain good idea, even if you don’t have to use one, it is really good insurance for you. Your investors are probably the ones paying for it. Most of the time, my legal fees are reimbursed to my sponsors, the syndicators, by their investors. So essentially, the investors are paying for your insurance policy. It’s kind of a no-brainer to do it.
Now, yes, it does take time and it does cost money. But it doesn’t make sense to risk everything on something that basically you could get for free. Not only that, but it does make a case that you are a professional. I can guarantee you that Goldman Sachs, when they’re doing a private offering for one of their clients or subsidiaries, does not do a deal without a private placement memorandum. Their legal department would never let them. So you showing up with your own PPM is a mark that you’re a professional, that you know what you’re doing, that the investors’ money is in safe hands because you know enough to protect yourself and you can probably protect their money too.
So here are the key takeaways: Private placement memorandums provide detailed information about your business, the financial health, associated risks, and all those things which are crucial for potential investors. A PPM also helps you comply with securities laws. It mitigates legal risks and enhances investor protection because it promotes clarity and understanding so they know what they’re getting into. They understand the investment terms and conditions.
While PPMs do require time and financial investment up front, they offer such advantages that it’s a clear case that you need to do this. It is a clear way to communicate exactly what your offering does. It gives the strategy and also attracts potential investors because you show up like a professional.
My name is Tilden Moschetti. I am a syndication attorney with the Moschetti Syndication Law Group. Obviously, I do a lot of private placement memorandums and I would be happy to talk with you about your private placement memorandum for your next offering.