Advantages of Raising Capital with a PPM
There are three main reasons to provide potential investors with a full private placement memorandum (“PPM”): (1) to effectively market your company to potential investors; (2) to negotiate with your investors from a position of strength and (2) to protect yourself from liability in the event of a lawsuit.
When you do a private offering prior to your IPO then you can give the investors a discounted stock price. For example, let’s say the stock price is valued at approximately $20 per share.
Thus, in order to induce your investors to invest, you will let them invest at a discount you choose, like at $17 or $18 per share (sometimes companies will allow them to invest even lower, like $15 a share). You can even let them invest at $18 per share with a grant of warrants that will allow them to buy even more shares post-IPO at $18 per share as well, that will include registration rights. The amount of warrants is usually tied to the amount they purchase. Example: Every two shares they purchase comes with one warrant (or one to one).
Negotiating from a Position of Strength with a PPM
The PPM will explain your company’s business as well as describe the class of stock and warrants, if any. Having a PPM gives you an advantage because you can start negotiating with potential investors from a position of strength because you have a PPM and the investors know that if they don’t accept the investment terms that you are offering that you can get another investor who will. Investors are less likely to propose new terms if you have a PPM. However, keep in mind that if an investor proposes new terms after they receive the PPM you can freely negotiate with them (in some cases you will want to amend the PPM).
How a PPM Mitigates Litigation Risk
These offerings come with risk. Let me explain. All IPOs have a very real risk that the investing public will not appreciate or notice the company and the stock price could fall once there are shares investors can buy and sell. There are so many reasons it could happen (likewise, there are many reasons it won’t happen). However, if you sold shares to investors at $18 a share as a discounted Pre-IPO investment, and then in the worst case scenario the share price drops to $15 per share (or lower), then the investors might initiate a lawsuit.
The best way to protect yourself from a lawsuit in the U.S. and in most other countries is to give them a fully compliant PPM. A fully compliant PPM contains a description of the business and competitors, audited financial statements and risk factors that clearly identify the risks, including the risk of total or partial loss of their investment. This PPM will protect the company and the company’s officers and directors personally from liability as much as possible and put you in the best position possible to defend any lawsuits.