Do I need a private placement memorandum (PPM) when attracting investors?

Yes. If you are seeking to raise investment money for your startup, keep in mind that the best measure you can take to protect yourself against frivolous claims is by disclosing as much information about your company as possible. This way, if things go wrong and your private investors threaten to sue you for securities fraud or the government files a regulatory action against your company, you can use your disclosures in your defense.

One of the best ways to disclose information to investors is to have Private Placement Memorandum (PPM) made for you by a lawyer. What is a PPM?

Disclosure Document

A PPM is a detailed disclaimer that includes relevant disclosures about your business that allow investors to weigh the risks involved with providing your company the agreed funding. PPM’s share similarities, but are all different due to uniqueness of the type of the business and characteristics of each investment. PPM’s should contain warnings regarding the business, its history and background, risks involved, financial forecasts, legal structure and ownership changes, and legal and financial details about the offer. It is very important the the PPM contains a warning that governmental regulations regarding protection of the public (consumers) do not apply.

PPM’s are Worth the Investment

Your PPM is more than an insurance-type expense. The PPM can be used in your defence against frivolous claims from both investors and government regulators.The PPM makes it harder for a potential claim to be successful and it improves your legal position dramatically.

It is important to keep in mind that, if investors are not informed regarding the risks involved, you open the door to legal action and investigation by the Financial Authorities. Please also keep in mind, that investors will not be very understanding when they loose money and do not care about the personal relations you have built up in the course of time.

Like a prescription drugs is obliged to explain risks, your investment offer must follow the same requirements. You should be prepared for the worst in terms of lawsuits and most even lawyers, when you start the process of attracting investors.

Why Explain Risks?

The risks involved with investing in your company must be described in great detail in a PPM. Disclosing these risks clearly before investors start funding your business is the best way to protect you from lawsuits claiming you defrauded or misled them.

Risk Factors to Describe

General risk factors are common for most or all private placement offerings. A disclaimer is needed in your PPM. Furthermore, investors may not be able to sell the securities for a given holding period and must be made aware of this. Specific risk factors should focus on the challenges your business faces. These include a disclaimer regarding its industry, customers, strategy, and management.

The following is an example in a PPM of some of the risks involving an debt or equity investment:

  1. Lack of operating history. The Company is recently incorporated and has therefore limited operating history upon which Investors can evaluate likely performance. There can be no assurance that the Company will achieve its Investment objective or that the strategy applied to the Company will be successful.
  2. Key individuals. The Company is highly dependent on–among other factors- the attracted Investments, professionals employed by the Company and its advisors. There can be no assurance that the Company will have continued access to them.
  3. Development risks. The Company may be exposed to development risks and the returns on the Investments may therefore be subject to some extent to the risks associated with the development of certain projects.
  4. Business and market risks. Any future market recession could materially adversely affect the value of Investments and the assets of the Company. Returns from an Investment are generally affected by overall conditions in the economy, such as growth in gross domestic product, employment trends, inflation and changes of interest rates. Furthermore, the financial condition and results of operations of the Company will depend on the ability of the Company to manage future growth and effectively implement its business strategy.
  5. Currency exchange rates risk. Company will be exposed to foreign exchange risks if it has receivables and payables whose values are directly affected by currency exchange rates. Contracts between two different firms with different domestic currencies set contracts with specific rules. This contract provides exact prices for services and exact delivery dates. However, this contract faces the risk of exchange rates between the involved currencies changing before the services are delivered or before the transaction is settled. Company also faces foreign exchange risks due to economic exposure – also referred to as forecast risk – if its market value is impacted by unexpected currency rate volatility. Currency rate fluctuations may affect the company’s position compared to its competitors, its value and its future cash flow. When the Company bids for foreign projects, negotiates contracts directly with foreign firms, or has direct foreign investments, it faces contingent exposure. When Company negotiates with foreign firms, currency rates will continuously change before, during and after negotiations occur.
  6. Interest rate risk. Fluctuations and changes in interest rates may adversely affect the financial condition of the Company.
  7. Law, regulatory regime and permits. Laws and regulations governing the operations of the Company may adversely affect the business, Investments and results of operations. The failure to obtain or to continue to comply with all necessary approvals, licenses or permits, including renewals thereof or modifications thereto, may adversely affect the Company’s performance, as could delays caused in obtaining such consents due to objections from third parties. New laws may be introduced which may be retrospective and affect the business which the Company is involved with. The Company could be adversely affected by delays in, or a refusal to grant, any required governmental approval, as well as by the application to the Company of any legal or administrative restriction.
  8. Litigation risk. Investment in the Company involves certain risks normally associated with Investment in the business of the Company, which includes for example the risk that a party may successfully litigate against the Company, which may result in a reduction in the assets of the Company. The Management is not aware of any pending litigation against the Company.
  9. Tax and regulatory changes. The tax regimes applying to the Company and/or its Special Purpose Vehicles (“SPV”), the ability of the Company to repatriate its assets and other operations of the Company are based on regulations which are subject to change through legislative, judicial or administrative action in the jurisdictions in which the Company and/or its SPVs operate and/or invest, thereby affecting the tax treatment of the Company and/or its SPVs in these jurisdictions.
  10. Operations of the Company. The Company may be unable to pay interest. The Company may not achieve the Company’s business objective. The Company may experience fluctuations in its half-yearly and yearly operating results.
  11. Interest payments. Investors should note that interest payments on the participations is not guaranteed and will be at the discretion of the directors after taking into account various factors including the Company’s operating results, financial condition and current and anticipated cash needs.
  12. Collateral. The Company, either directly or indirectly through its SPV’s, may use property or other assets as collateral to secure a loan. If the Company stops making the promised loan payments, the lender can seize the collateral to recoup its losses.
  13. Insolvency. It is possible that the Company, due to many unpredictable and/or predictable factors, might become insolvent, whereby the potential Investors could lose all value of their Investment. However, currently there is no indication that such situation will occur in near future.
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