Private Placements and Business Plans

Today, we’re going to talk about the difference between a private placement memorandum and a business plan. Often, many entrepreneurs make the mistake that a business plan is a legal document or the investment contract between the business, the entrepreneur, and the private investment source. However, a business plan is not a legal document. It is a sales document that focuses on the product or service offered by the business, how much money is going to be needed to launch the company, and the anticipated financial results over a three-year to five year timeframe. A private placement memorandum, commonly referred to as a PPM, is the actual legal document that is used between the entrepreneur with a business and a group of private investors.

Not every company that is seeking private investment requires a private placement memorandum. Usually, if an individual is sourcing capital directly for a venture capital firm, a single investor, or private equity group in a private placement memorandum is not going to be needed. However, there are a myriad of both federal and state securities laws that guide the capital raising activities when funds are being sourced from individuals or non-bank entities. Only a qualified attorney can make a determination as to whether or not a specific business will be subject to securities laws as a result of the capital raising activities. If the individual is seeking to sell shares of the business to a number of different private investors in a private placement memorandum is always going to be needed.

The private placement memorandum documents the risks associated with the business, how much capital is going to be used, the allocation of profits to each partner, and all the necessary risk disclosures that are required by law. The private placement memorandum typically does not focus significantly on the forward-looking financial statements related business activities but rather focuses on the control that investors will have as a result of owning a share of his business. These are highly complicated documents and most private placement memorandums run anywhere from 30 pages to 60 pages depending on the complexity and structure of the business. It is expensive to have this type of documentation produced by a qualified attorney. As we discussed in a previous article, most PPM documents have a price of around $4,000 to all the way up to $20,000 depending on the scope and scale of the business.

There are some companies out there that are operated by non-attorneys that offer a fill in the blank template for a private placement memorandum. However, given the legal nature and the complexity of this type of document it is important that a qualified attorney develop this documentation so that new mistakes are made. A mistake in a private placement memorandum or similar investment contract could have substantial legal ramifications if there is a dispute among the entrepreneur and the group of investors who have put the money into the business. Although this is a significant upfront expense, the benefit is that in the event of a disagreement the contract can be easily reviewed in arbitration or in a court of law.

Unlike the private placement memorandum, the business plan has no such disclosures of risk outside of general economic and business risks. Additionally, the business plan does not focus on the percentages of equity that each partner will get as a function of how much capital they are contributing to the business. Again, the business plan primarily serves to showcase to a potential funding source exactly with the business is looking to do, how will market its products and services the general public, and related information as it relates to the management and general operations of the company.

One of the key things that can be done prior to even developing the business plan is to work with a qualified attorney to determine what documentation would be needed based on the types of capital being raised. This will ultimately save the entrepreneur a significant amount of time and money given that they will understand exactly what they need to do prior to engaging in expensive business plan writing firm or a securities attorney that is going to have to draft a large-scale private placement memorandum.

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