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Private Placement Memorandum: Using a PPM to Raise Private Capital

by Ankit Duggal on January 21, 2013 · 13 comments

  
Private Placement Memorandum

Are you familiar with a PPM – also known as a Private Placement Memorandum?

A PPM can protect you and your personal assets as you raise money from capital investors.

As a real estate investor, it is important that you learn more about PPM’s and how you can use it to raise private capital for your investment business.

What is a Private Placement Memorandum (PPM?)

PPM = Private Placement Memorandum. A PPM is a private offering where investors invest in your Special Purpose Vehicle (SPV), which can be either an LLC or LP and the investment is backed by whatever that SPV owns i.e. real estate, notes, stocks etc.  Most people think that the purpose of a PPM is to raise money — rather the true purpose of a PPM is to provide the full disclosure envisioned by the federal securities law. Hence it is a CYA (Cover Your Ass) rather than a fund raising tool (in my opinion.)

Key Questions for your Private Placement Memorandum

Everybody in real estate knows the acronym OPM. OPM (Other Peoples Money) means raising money from third parties to help accomplish your investment or business plan goals. If you want to raise money from third parties then it is important to understand to think through key questions, as your attorney will need answers to these question as they help you draft your PPM:

  • What is your asset investment or overall business plan and how does OPM work within that plan?
  • What is your track record, your model, or who your modeled after?
  • How will the investors participate and how and when will they receive their return on capital? You have to determine if you’re going to pay a return and an upside (which could lead to more scrutinizing of expenses).
  • How to market this offering and to whom;  Are you only going after accredited investors (high net worth individuals) or will you consider sophisticated unaccredited investors as well?
  • What’s the exit look like? When do they get there capital back? Do you do different tiers of interest rate based on how much money is contributed or the length of term?

A PPM, like a business plan, is a great thinking and planning tool as you start down the path of raising private capital, especially from third circle investors.

Key Parts to a Private Placement Memorandum?

The Private Placement Memorandum (PPM) is a document that can feel shrouded in mystery and complexities and you do need a good local securities lawyer and CPA team as you finalize your PPM. As real estate investors it is important understand what these experts will be doing for you, as that way you can intelligently add to the process and maybe save some costs as well. Hence I have spent the last few months reading through sample PPM of REITS (hint: you can get a great boilerplate language of risks and conflicts by reviewing public REITS either 10-K or their initial IPO filing document) and reviewing Guide 5 issued by the Securities and Exchange Commission. Release No.33-6405 (June 3, 1982) (47 FR 25140). Below is my synopsis from reading and dissecting of pages and pages of information.  

There a four major parts to a PPM document:

1.) Introduction 

The introduction is the cover page of the PPM which includes a brief summary of the offering, description of the asset or assets to be purchased, the termination date of the offering period, minimum investment required, a brief statement of the key risks, suitability standards statement, and a disclosure of the commissions & fees payable to the Sponsor and Third Parties.

2.) Basic Disclosures

Sponsor Information

A PPM must provide enough information to help capital investors judge the capabilities and risks of the sponsor. The PPM must disclose the key items associated with a Sponsor:

  1. Manager name, address, and telephone number
  2. Fees and Profits Table detailing the fees to be paid out to the Sponsor
  3. Manager Biographical information
  4. Prior Sponsor Performance:
    1. Narrative report of the track of the prior performance of real estate investment groups that have been sponsored by this sponsor during the past 10 years for similar investments.
    2. Raising & Investing Funds Performance Table: the table will show the sponsors experience in raising and investing funds where the money raising has been completed of prior investments.
    3. Operating Results Performance Table: the table will show the operating results of prior investment assets that have been completed or have “gone full cycle.”
    4. Compensation Table: the table will show the compensation paid to sponsor for prior investments.
    5. Track Record: this table or narrative will provide the results of the sponsor’s prior programs/syndications that have been completed.

Specified Property Offering

The specified property offering section of the PPM will provide the key information associated with the asset description together with estimated project costs, use of proceeds table, and gross  sales revenues. It is important to note that the PPM document itself never mentions projected returns that an investor can make rather that information is provided via an Exhibit that provides a detailed project proforma. So make certain that your PPM document does not include a projected returns either asset or investor level within the PPM document.

Risk Factors

The PPM should contain a whole section relating to the various types of risks associated with investing in this opportunity. The risks categories will typically include asset, environmental  tenant, market, asset, legal, tax and risks associated with the sponsor and SPV (LLC holding the property). It is also important to think through and include any risks that are unique to this investment offering that may not be present in other offerings i.e. a special risk associated with the tenant or the asset location

3.) Legal Agreement

The legal agreement refers to the operating agreement or the limited partnership agreement that will govern the manner in which the SPV will be run and include information about key  issues:

  • Investment of the members of the group
  • Accounting rules of the group
  • Management plan to follow
  • Rights of members of the group
  • Ability to assign or transfer an ownership unit
  • Communication plan for the group
  • Termination of the group

4.) Subscription & Offering Questionnaire

The subscription agreement is an application document signed by the capital investors to purchase a certain number of investment units within the offering. The subscription agreement will usually be accompanied by a check or a wire by the capital investors.

Summary

Once you get that check, a real estate investor is usually on cloud nine, but there is a critical step that you need to take prior to cashing it. It is important to validate the sutiability of this investment to the investor. Utilize the offering questionnaire to asses the suitability of the investment for that particular investor and if it is not a match then it is better to return the money rather face a potential lawsuit in the future.

The Private Placement Memorandum is a great planning and CYA tool. If there any best practices that you know about it regarding utilizing a PPM, please share them through the comments below.

Until next week, Happy Investing.
artist in doing nothing

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{ 13 comments… read them below or add one }

Page January 21, 2013 at 10:47 am

Interesting post with some great details. I have an investor interested in kicking in some funds for a rehab project, and would prefer to give them the PPM and promissory note and not put them on the loan since its a short-term construction loan that will be secured in my name, refinanced after construction and then quit claimed to the LLC. Since their investing in the LLC, would this make the loan secured and allow me to write off the interest and file taxes correctly?

I’ll speak with an attorney if this flies, but interested in your take.

Reply

Douglas January 21, 2013 at 11:44 am

Hello Page,

I appreciate that your taking massive action!! Please note this does not constitute legal advice by my educated opinion is that you don’t need to draft a PPM in the scenerio you mentioned. Overkill in your hypothetical as this article is contemplating an private placement offering.

The key thing to remember if your contemplated agreement is a security is called the Howey test (SEC v Howey 1946). The test says if the agreement calls for:

1. an investment of money due to

2. an expectation of profits arising from

3. a common enterprise

4. which depends solely on the efforts of a promoter or third party

It rings the bell of the securities regulation protection scheme.

The agreement you identified if drafted correctly can avoid the expense of the securities registration process.

Good luck on your project. You came to the right place.

Reply

Russel M. January 21, 2013 at 1:40 pm

Great information regarding the PPM thanks Ankit. I will definitely use this information

Reply

Ankit Duggal January 21, 2013 at 4:19 pm

Thank Russel. I appreciate the fact that you found the information useful

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kris January 21, 2013 at 2:18 pm

+Got into apartment and office. Now will lose all investment, they did not delivered what they promised after 5yrs, and lender will take away property. Risky!!!

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Brian Burke January 21, 2013 at 11:58 pm

Ankit, great overview of the PPM. I totally agree with your opinion that the PPM is not a fundraising tool. After reading a properly drafted PPM, most investors would say that there is no way they are investing in the deal! It is page after page of potential risks. A necessary component of the process, however.

An investor that is truly suitable to invest in the deal will not be turned off by the disclosures in the PPM (unless its a disclosure that the sponsor is a criminal or bankrupt), so while it is not a marketing tool, it IS a filtering tool. If the potential investor is turned off by the risks disclosed, it is much better to discover this early in the process rather than after they invest.

I use an executive summary and a fact sheet to market my offerings. If the investor is still interested after reviewing those documents, then they get the PPM and Subscription Agreement. No one wants to read a PPM until they are pretty sure that this offering is a fit for their objectives. They are no fun to read!

Great article, thanks for sharing.

Reply

Ankit Duggal January 28, 2013 at 2:39 pm

Brian great explanation on what a PPM should do to an investor mindset.

Reply

Alejandro Casablanca October 7, 2013 at 5:18 pm

Hello Ankit & Brian

I was doing some research in Bigger Pockets about the PPM tool and I got to your article, which is very informative. I’m now working with an Investment / Executive Summary for a deal that I’m working on and I’m just wondering if it would be appropriate or can be considered customary disclosing financial and profitability highlights, such as approximate ROI, interest rate to be paid, etc. Or if those are details that are simply disclosed formally in the PPM itself?

Your feedback on this will be very appreciate it.

Reply

Colm McCormack January 25, 2013 at 8:14 am

Thanks, Ankit! I learned a lot from your post!! The way I manage private investor money is by doing joint ventures with them. It’s really very simply; they loan me the money by wiring it to the title company to buy & rehab the house then we split the net-net-net profits on the back end. We do this via a non recourse Note and Deed of Trust. That way the only secuirty is the house we are fixing, not me and not my company. Basically, they’re the bank.

Reply

Brian Lunsford January 28, 2013 at 8:54 am

Is there a threshold or number of investors that trigger an offering from a private money loan. I like Colm’s simplicity better, but not sure of the validity. Also, I presume that state laws will differ and you are only speaking of SEC requirements.

Reply

Ankit Duggal January 28, 2013 at 2:37 pm

Brian state laws can differ. Technically you need disclosures even when they are investing as the bank. It is simpler I agree but they need to get disclosures and some kind of risk document even with a loan security instrument.

Reply

Curt February 19, 2013 at 9:48 am

Is the PPM apart of a Fed/State SEC registration or is the PPM solely between the fund manager (you/me) and the investor/lenders?

Any suggestions on what internet resource (there’s many) to buy a PPM template from?

Any suggestions on where to buy the Reg D form D and other Fed/State forms from?

Thanks, curt

Reply

Shayne February 4, 2014 at 11:40 am

Ankit,

Great article! I am a new investor but have dove right in recently. Found a couple great deals that I am working and I was wondering if there was somewhere I could go to get example disclosures and agreements?

Reply

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