Nic McGrue is a tenured law professor and attorney at Polymath legal pc.
Scaling up a business or taking on a major project often requires capital. Financing is one way to get some of that capital, but in most cases you won’t be able to get 100% financing for your project. So you have to put equity on the table. You can bring your own personal capital to the table, or you can ask investors to bring in the financial capital while you bring in the sweat capital.
As a securities attorney, I have helped clients raise capital through private offers. If you find partners to bring in equity as you do the work, those equity partners are likely passive investors. Passive investors usually mean that your investors pay money and expect to share in the profits without doing the work that produces those profits.
When you have passive investors, in many cases you sell a security. If you sell a security, you must register the security or find and comply with an exemption from registration. There are several capital increase exemptionsincluding but not limited to Regulation D, Regulation a And Crowdfunding schemeaccording to the Securities and Exchange Commission.
Securities exemptions require certain disclosures of non-public information. Whether you are registered or not, you, the issuer of the security, must provide any potential investor with information that will enable them to adequately assess the risks and merits of that deal so that they can make an informed decision as to whether the investment opportunity fits their financial position. objectives and risk appetite.
Unlike registered securities, which require extensive disclosure of information, exempt securities are typically required to disclose only minimal information. While exempt securities typically do not require extensive disclosure, disclosure of relevant information, even if private, is still required before taking capital from investors.
One way to meet the disclosure requirements of an exempt securities offering is to provide investors with a private placement memorandum.
What is a private placement memorandum?
A PPM is a disclosure document. Sometimes these disclosure documents are referred to as an “offering circular” or “prospectus”.
Regardless of the name, they will generally disclose much of the same information, which usually includes: the name and contact information of the company or publisher; the name, title, biography and background information of the management team; the business plan; the suitability and requirements of the investor; the general offer conditions; the manner in which distributions will be made and how any profits will be shared; compensation paid to company executives; the use of proceeds; financial projections; restrictions on transfer; and risk factors of the investment, among many other things.
If you say to yourself, “That sounds like a lot of information,” you’re right. Why do we need all this?
First are revelations legally required. As mentioned earlier, exempt securities offerings do not have many disclosure requirements. This is in stark contrast to named securities. A registered security typically allows investors to search EDGAR, the SEC’s reporting database, and find all sorts of information about a company, even down to executive salaries. Because exempt securities lack that public transparency, the SEC forces exempt securities issuers to privately disclose this information to potential investors.
Second, the disclosures made in a PPM serve not only the issuer’s legal duty to disclose, but also a practical protection purpose. Investors generally want to trust the company and the operators of the company they are investing in. From my perspective, it is much better for an investor to shy away from a risk factor you disclosed while you don’t have their money than to hide a risk factor and let the undisclosed worst case scenario happen while you have their money .
In the first scenario, you miss out on investment capital that could have helped your deal. In the second scenario, there is a chance that the investor could take legal action against you, which would cost you time and resources to work on your deal. In addition, you may also come under scrutiny by the SEC and be subject to any sanctions it deems necessary.
Why can PPMs be useful?
Technically, all of these disclosures can be made in several one-time documents or other forms of communication; disclosure need not be made specifically in the form of a PPM.
However, I have found that a PPM can be useful if you ever need to prove that disclosures were indeed made and received. The receipt of PPMs is usually signed by the investor. If the issuer was ever asked if it has provided certain disclosures, having a document, the PPM, containing those disclosures with the investor’s acknowledgment of receipt can go a long way in substantiating that the issuer has provided the required disclosures. The publisher could shred several documents, but this could cause confusion, allow for errors or failed disclosures, and create some uncertainty about when and if a disclosure was made. A PPM can help eliminate or drastically reduce these problems.
When deciding how to raise capital for a project or scale a company, remember these key points: There are several exceptions that can be used, but they all require some level of information disclosure. And a PPM can be used to meet those disclosure requirements and enable potential investors to make an informed decision about participating in and investing in an exempt securities offering.
The information provided here is not legal advice and is not intended to be a substitute for advice from legal counsel on any specific matter. For legal advice, you should consult a lawyer about your specific situation.
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