A private placement memorandum (PPM) presents an opportunity both to sell your privately offered securities to investors and to protect your company’s interests. It is important to keep in mind that, while you do want the document to help compel investors to move forward, if they do so without a full understanding of the risks involved you open the door to legal action and investigation by the Financial Authorities.
Much in the same way that a prescription drugs must explain risks in public advertisements, securities must do the same. While health and life is at stake with prescription drugs, the savings and financial security of investors are at stake in a private placement due to the volatile nature of the returns they can expect. You should be prepared for the worst in terms of lawsuits, even while hoping for the best.
Why Explain Risks?
The risks involved with investing in your company must be laid out carefully in a private placement not because of a government requirement to do so (the federal disclosure requirements are limited, although you should consult with a lawyer who knows both federal and state securities law). Disclosing these risks clearly before investors part with their cash is the best way to protect your firm 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 touch on the challenges your firm faces. These include challenges to its industry, customers, strategy, and management. For example, if there is a chance that key management members will leave the company and cause a need for a costly search for a replacement, this should be covered. If competitive threats may derail the plans of the business entirely, this should certainly be mentioned. Covering risks specific to the firm reduces the chances that an investor will cry foul and file a lawsuit if these worst-case scenarios occur. If you are sued, the PPM serves as a clear record that you communicated the risks from the outset.