Understanding Common Corporate & Securities Investment Documents for Private Offerings – Part 1
By Jor Law / Issue 2
In the United States, the act of raising capital generally involves a combination of corporate laws and securities laws. For immigration-based investment programs, such as the popular EB-5 program, immigration laws are also involved. Indeed, this is true of many countries around the world although some countries may not have as defined corporate, securities, or immigration laws.
In the US, most capital raises are conducted as non-public offerings because they are exempt onerous laws that require the registration of securities being offered to the public. Interestingly enough, recent US laws allow a company to generally solicit and advertise an offering yet still allow that offering to qualify as an exempt private offering for legal purposes. Just because you publicly hear about an offering doesn’t mean that it isn’t treated as a private offering under US law.
This article is Part 1 of a two-part series that explores some of the different corporate and securities documents one might find in a typical offering of United States private securities. Part 1 explores the differences between disclosure documents and transactional documents and generally describes the roles of disclosure documents and the private placement memorandum (PPM). Part 2 will describe various transactional documents.
Disclosure vs Transactional
It is important to understand the distinction between disclosure documents and transactional documents. Transactional documents are the agreements or contracts that govern the actual investment and agreed upon rights and obligations between the company raising capital and its investors. For EB-5 investors, for example, the transactional documents evidence their investment and govern their rights and obligations in connection with their EB-5 investment. As such, the transactional documents are crucial to their EB-5 application. Without proper transactional documents, they can never be approved for an EB-5 visa.
Disclosure documents, on the other hand, don’t generally contain any contractual terms or conditions. Instead, they serve the role of divulging information about the capital raise. They are important in terms of legal compliance with securities laws to ensure that investors are adequate informed of the risks of their investment, but they do not usually create any contractual relationship between a company and its investors. So while almost all the emphasis on legal compliance is placed on the PPM, which is a disclosure document, it could be argued that the definitive transactional documents are more important. For how most private securities offerings are structured, it might be surprising to note that the PPM is technically not required. In the EB-5 industry, that means investors in projects without PPMs can still get their EB-5 visa applications approved by the government.
Disclosure Documents & the PPM
In the United States, one of the principal goals of the securities laws is that companies offering securities for investments must provide accurate and complete information about their businesses, the securities they are selling, and the risks involved in investing in the securities. Material information, which is generally regarded to be information that would be substantially important to a reasonable investor in deciding whether or not to make the investment, must be disclosed. The documents that provide these disclosures to investors are collectively known as disclosure documents. Certain types of capital raises have specific disclosure requirements and may require disclosures to be made following a certain format. For most private offers made only to accredited investors, however, the disclosures can be made anyway the company chooses to do so. In the private offering space, the generally accepted best practice is to compile all the disclosures into a PPM. That way, there is reasonable certainty as to what information was actually shared with investors, and to a lesser degree of certainty, what information was not shared with investors. The PPM exists both as a tool for investors to learn material facts about the investment they might make as well as a tool for issuers to limit their liability to claims that they did not make adequate disclosures.
It’s important to note that the cost of preparing a PPM is relatively high; accordingly, for offerings of a small dollar amount or offerings to a small number of investors that the company knows very well, a PPM is often not prepared. An offering without a PPM does not mean that the offering is not legally compliant, nor that the offering is a bad one. While it’s legally advisable to have a PPM in every offering, there are valid business reasons to forego the PPM. In venture capital, for example, the norm is to not have PPMs for early-stage capital raises. Venture investors are typically sophisticated enough to conduct their own diligence, and they prefer that their startups spend their investment dollars on growing the business rather than to create a PPM which actually helps protect the startup against the investors rather than help serve the investors.
Please read the next edition of Trade & Invest America | The EB-5 Gateway for Part 2 of this two-part series on “Understanding Common Corporate & Securities Investment Documents for Private Offerings”