Raising Funds: What is a Private Placement Memorandum?
A Private Placement Memorandum is sometimes referred to as a confidential offering circular or an offering memorandum. Private Placement Memorandum’s are used by private companies who intend to stay private and as part of a going public transaction. Private placements are also used by existing public companies to raise capital by selling either debt or equity pursuant to an exemption from SEC registration such as that found in Rule 506 of Regulation D. Private Placement Memorandum disclosures vary depending on whether the investor is accredited or non-accredited and whether the Company is subject to the SEC’s reporting requirements. When a Company sells equity, it most often offers common shares to investors who become shareholders of the Company. In going public transactions, the shares held by these investors will often by registered on Form S-1 so that the Company meets the requirements of the Financial Industry Regulatory Authority (“FINRA”) to obtain its ticker symbol assignment.
The common exemptions from SEC registration for companies using Private Placement Memorandums to raise capital are provided by Regulation D of the Securities Act of 1933, as amended (the “Securities Act”). The most common exemption from SEC Registration is Rule 506 of Regulation D which provides for two unique exemptions from SEC registration that allow the issuer to raise unlimited amounts of capital if it complies with the specific requirements of each rule. As discussed in more detail below, Rule 506(b) permits sales to up to 35 non-accredited investors and an unlimited number of accredited investors while Rule 506(c) allows sales to be using general solicitation and advertising so long as the issuer verifies that all investors are accredited purchasers.
Under Rule 506(b), a “safe harbor” under Section 4(a)(2) of the Securities Act, a company can be assured it is within the Section 4(a)(2) exemption by satisfying certain requirements, including the following:
- The company cannot use general solicitation or advertising to market the securities.
- Unlike Rule 506(c) discussed below, no accredited investor verification is required.
- The company may sell its securities to an unlimited number of “accredited investors” and up to 35 other purchasers. All non-accredited investors, either alone or with a purchaser representative, must be sophisticated—that is, they must have sufficient knowledge and experience in financial and business matters to make them capable of evaluating the merits and risks of the prospective investment.
- The company must be available to answer questions by prospective purchasers.
- For Rule 506(b) offerings, each non-accredited investor must receive an extensive disclosure document with almost as much detail as that required in SEC Registration Statements and Regulation A Offering Circulars. For example, depending on the size of the offering, issuers are required to provide the most recent balance sheet, income statements, statements of stockholders’ equity, and similar audited financial statements for the preceding two years, as well as a description of the issuer’s business and the securities in the offering. The issuer must also give non-accredited investors a brief written description of any material information about the offering that is given to accredited investors. In short, the information required to be provided under Rule 502(b)(2) is much more comprehensive that the information typically provided in a private placement memorandum to accredited investors.
Under Rule 506(c), a company can broadly solicit and generally advertise the offering and still be deemed to be in compliance with the exemption’s requirements if:
- The investors in the offering are all accredited investors; and
- The company takes reasonable steps to verify that the investors are accredited investors, which could include reviewing documentation, such as W-2s, tax returns, bank and brokerage statements, credit reports and the like.
Private Placement Memorandum Disclosures
When a Company uses a Private Placement Memorandum to raise capital, it should be prepared to provide investors with expansive disclosures including financial information. The consequences of the Company failing to do so in its Private Placement Memorandum can prevent the Company’s offering from qualifying for an exemption from the securities registration requirements. It is therefore important for the Issuer to adhere strictly to the requirements for making a nonregistered offering of its securities. Should it fail to do so, the Company, its directors and its executive officers become personally liable and the investors will be able to rescind their investment.
Upon compilation of the Private Placement Memorandum, all members of the Company’s management should read it for accuracy and ensure that the information contained therein is truthful and that all material information is disclosed. It is critical that the Private Placement Memorandum not contain misstatements of material information or omissions of material facts, in order to make the disclosures not misleading. The Private Placement Memorandum should be amended if any of the disclosures made in the Private Placement Memorandum become inaccurate or misleading. The Company should not use any sales literature that has not been reviewed and approved by its legal counsel. Management and representatives should be cautious in any verbal or written statements to potential investors that may contradict or modify the Private Placement Memorandum disclosures. Most importantly, the Company and its representatives should never make representations about increases in its stock price or offer assurances about the Company’s prospects, its profits, or potential returns on an investment.
The failure to be provide proper disclosures in a Private Placement Memorandum may subject the Company as well as its management to civil action including rescission rights. Both could also be subject to SEC Enforcement actions including fines, prohibition on future securities offerings, and criminal actions prosecutions should the Department of Justice become involved
For further information about this securities law blog post, please contact Brenda Hamilton, Securities Attorney at 101 Plaza Real S, Suite 202 N, Boca Raton, Florida, (561) 416-8956, by email to [email protected] or visit www.securitieslawyer101.com. This securities law blog post is provided as a general informational service to clients and friends of Hamilton & Associates Law Group and should not be construed as, and does not constitute, legal and compliance advice on any specific matter, nor does this message create an attorney-client relationship. Please note that the prior results discussed herein do not guarantee similar outcomes.