When a sponsor raises private capital, the private placement memorandum, or PPM, is usually the longest document in the package and the one investors are asked to read most closely. It is also widely misunderstood. Some sponsors treat it as a legal formality, and others assume every private offering needs one by law. Neither view is quite right. Here is what a PPM does, when federal rules effectively require one, what it usually covers and why accuracy matters so much.
What a PPM is
A PPM is a disclosure document for a securities offering that is exempt from SEC registration. It describes the company or project, the people running it, the terms of the investment, how the money will be used and what could go wrong. It is not the same as the operating agreement or the subscription agreement. The operating agreement sets the rights and duties of the owners, and the subscription agreement is the contract through which an investor buys in. The PPM explains the investment, and it should be consistent with both.
Is a PPM legally required?
The answer depends largely on who is buying. Regulation D does not use a single rule for every Rule 506 offering.
Rule 506(b) with non-accredited investors
Rule 506(b) allows sales to up to 35 sophisticated non-accredited investors in any 90-day period. Once a non-accredited investor is involved, Rule 502(b) requires the issuer to furnish specific information a reasonable time before the sale. For a non-reporting issuer that is eligible to use Regulation A, this means the same kind of information required in Part II of Form 1-A, along with financial statements tied to the Form 1-A requirements. The financial statement standard becomes stricter for offerings of more than $20 million.
Rule 502(b) adds other obligations too. Non-accredited purchasers must receive a brief written description of any material written information given to accredited investors, and they must be told about resale limits. In practice, a PPM is the usual way to deliver all of this, which is one reason many sponsors find that adding even one non-accredited investor changes the cost and complexity of a raise.
Offerings sold only to accredited investors
Rule 502(b) does not require issuers to furnish this information to accredited investors, so a PPM is not automatically mandated in an accredited-only deal. That includes Rule 506(c) offerings, where all purchasers must be accredited and the issuer must take reasonable steps to verify their status. But no disclosure mandate does not mean no disclosure duty. Antifraud rules still apply to every sale, and Rule 502(b) itself says issuers should consider providing this information to accredited investors as well in light of those provisions. Many sponsors use a PPM in accredited-only deals for that reason.
What a PPM typically covers
There is no universal template, and the content should fit the deal. A PPM for a real estate syndication or fund will commonly address:
- Summary of terms: the security being offered, the amount being raised, minimum investment and key dates.
- The sponsor and management: who is running the deal, their relevant background and their roles.
- The business plan: the property, strategy or investment criteria, and how the sponsor expects to carry out the plan.
- Sources and uses of funds: where all project money comes from, including debt and equity, and where it goes.
- Fees and conflicts of interest: what the sponsor and its affiliates are paid, and where their interests may differ from those of investors.
- Distributions and investor rights: how cash flow and sale proceeds are shared, plus voting rights and any capital call provisions.
- Risk factors: risks specific to the project, the market, the financing and the investment, including the possibility of losing the entire investment.
- Financial information: required statements, along with any projections and the assumptions behind them.
- Resale restrictions: the fact that the securities are not freely transferable and that investors should expect to hold them for an extended period.
- Tax considerations: general tax issues that should prompt investors to speak with their own advisors.
- Investor qualifications and subscription steps: who can invest and how the subscription process works.
Every purchaser in a 506(b) offering that includes non-accredited investors must also have the opportunity to ask questions and receive answers about the terms of the offering. A PPM often explains how to do that.
Bad actor disclosures
Rule 506(d) can disqualify an offering from Rule 506 if the issuer or another covered person has a disqualifying event that occurred on or after September 23, 2013. Rule 506(e) covers matters that would have been disqualifying but happened before that date. Those earlier events do not disqualify the issuer, but they must be disclosed in writing to each purchaser a reasonable time before sale. Sponsors should screen the people involved before the offering begins and build any required disclosure into the documents.
Why accuracy matters
A PPM is not just a sales tool. It is a written record of what investors were told, and it can protect a sponsor if it is accurate and complete. It can also become central evidence if it is not.
Under federal law, investors may bring claims under Rule 10b-5 for material misstatements or omissions, and Section 20(a) of the Securities Exchange Act can extend liability to people who control the issuer. In Ohio, R.C. 1707.41 addresses liability for a false material statement or omission of material facts in a written offering document when a buyer relied on it, and R.C. 1707.44(B) prohibits knowingly making false representations about a material and relevant fact when selling securities. Forming an LLC does not necessarily keep the people behind the deal out of these claims.
Common mistakes
- Using generic risk factors. A borrowed list that says little about the actual property, market or business plan may not disclose the risks that matter most.
- Letting documents drift apart. The PPM, operating agreement, subscription agreement, pitch deck and website should tell the same story about fees, distributions and investor rights.
- Presenting projections as promises. Forecasts should be labeled as such, with the key assumptions explained.
- Ignoring changes. If a material fact changes during the raise, such as the purchase price, financing terms or timeline, the disclosure may need to be updated before more investors subscribe.
- Choosing the exemption too late. Whether non-accredited investors can participate and how investors are found both affect what the documents must say.
Getting started
Before drafting a PPM, it helps to gather the following:
- A clear decision on whether the offering will use Rule 506(b) or Rule 506(c), and whether any non-accredited investors will be allowed.
- The proposed entity structure and the economic terms, including all sponsor fees and distributions.
- Background information on the principals, plus responses to bad actor screening.
- The property or business information, financing terms and a full sources and uses budget.
- Any financial statements and projections, along with the assumptions behind them.
- A list of the states where investors are likely to be located, so that state filing requirements can be addressed.
Vincent Esquire helps real estate sponsors and business owners structure private offerings and prepare the documents that go with them. Learn more about our SEC compliance and capital raising services or reach out to talk through your raise.
This article is for general informational purposes only and is not legal advice. Reading it does not create an attorney-client relationship. Laws change and every situation is different, so consult an attorney about your specific circumstances. Attorney advertising.
