A private placement securities offering includes a number of documents, which collectively comprise the offering package. Each document has the specific purpose described below:
The Private Placement Memorandum
The private placement memorandum (PPM) essentially “tells the story” of the investment. Legally, it is the disclosure document required by the SEC or applicable state securities agency for certain private placement offerings. It describes such things as the structure of the company, projected returns to investors and compensation to the manager, the risks of investing, potential conflicts of interest and a summary of how the company will be operated, among other things. The rest of the documents within the offering package are attached to the private placement memorandum.
The Investment Agreement
The “investment agreement” is the enforceable contract between the issuer of the securities and the investors. It can take many forms. The most common agreements used in real estate securities offerings are described below.
Limited Liability Company Agreement Or Operating Agreement
This document describes how a limited liability company will be operated. Legally, it is the governing document for a limited liability company and describes in detail such things as:
- The rights and duties of the members (investors) and the asset manager,
- What investors are buying (units or interests),
- How meetings and votes of the members will be conducted and the required percentage for a measure to pass,
- How and when cash distributions will be made and the associated “waterfall” for distributions in various stages of the company,
- Management fees,
- Liquidation of company assets, and admission or disassociation of members, among other things.
When a limited liability company is managed by a manager (i.e., “manager-managed”), and the members include passive investors (who are not involved in management) the operating agreement creates an “investment contract”. As described previously, investment contracts fall within the definition of Securities in The Securities Act of 1933 and all state securities acts – and thus all sales of passive interests in a limited liability company to passive investors must comply with securities laws.
When a limited liability company is managed by its members (i.e., “member-managed”) and all members are actively involved in generating their own profits, the operating agreement is not an investment contract, and does not require compliance with securities laws. In that case, it would be a “joint venture”, and all that would be needed is the operating agreement.
Limited Partnership Agreement
This document has the same role as a limited liability company agreement, but for a limited partnership. It describes the rights and duties of the “general partner” (who has the same role as the manager of a limited liability company) and the limited partners (investors). It also describes what the investors are buying (usually limited partnership interests or “LP” interests).
When a limited partnership is selling interests to passive investors, the limited partnership agreement is an investment contract, within the definition of Securities – and thus all sales of interests to passive investors (who are not members of the “general partner”) must comply with securities laws.
Shareholder Agreement
This document has the same role as a limited liability company agreement, but for a corporation. It describes the rights and duties of the officers (managers) and board of directors and the shareholders or stockholders (investors) of the corporation. It also describes what the investors are buying (shares or stock).
When a corporation is selling interests to passive investors (who become shareholders or stockholders), the shareholder agreement is an investment contract, within the definition of Securities – and thus all sales of stock or shares to passive investors must comply with securities laws.
Trust Agreement
This document has the same role as a limited liability company agreement, but for a business trust (such as a Delaware Statutory Trust) or title holding trust with multiple beneficiaries. It describes the rights and duties of the trustee (manager) and beneficiaries (investors) of the trust. It also describes what the beneficiaries are buying (beneficial interests).
When a trust is selling beneficial interests to passive investors, the trust agreement is an investment contract, within the definition of securities – and thus all sales of beneficial interests in a trust to passive investors must comply with securities laws.
Promissory Note
This is not an investment contract, as it is a separate category in the definition of securities under The Securities Act of 1933 and state securities acts.
This is the contractual agreement used when an investor makes a loan in exchange for promise to pay, signed by the borrower (i.e., a “promissory note”). Promissory notes generally describe the terms of the loan.
The issuer of the promissory note is the borrower, and the lender is the investor. The lender could be an institutional lender such as a bank or credit union, a hard money lender or a private individual. The promissory note describes such things as:
- The purpose of the loan,
- The principal loan amount,
- The payment schedule, and whether the payment is interest-only or principal plus interest,
- Interest or shared profits to be paid to the lender (how calculated, when due),
- Points or origination fees owed to the lender,
- The duration and maturity (end date when principal must be repaid),
- Whether the borrower’s personal guarantee is required,
- What constitutes a default and lender remedies in case of default, and
- Collateral for the loan (i.e., property the lender can acquire if the loan is not repaid according to the terms of the note).
The Subscription Booklet
The subscription booklet is document that tells the issuer about the potential investor. In filling out this booklet, investors make representations and warranties as to their qualifications and suitability to invest. The booklet also includes a place for the issuer’s acceptance and acknowledgement of the investment. The investor will attest, usually under penalty of perjury, that:
- They meet the qualifications of the exemption the issuer is using;
- They have read all of the documents provided by the issuer and have obtained satisfactory answers to all of their questions;
- They have sought all legal, financial or tax advice they deemed appropriate;
- They understand the risks of the investment;
- They can afford to lose the money;
- The amount they plan to invest, and
- How they plan to own their interests.
The Investment Summary
The “investment summary” is a document containing information about the property that is the subject of the offering and biographical information about the members of the asset management entity.
The “investment summary” is a marketing piece that is meant to describe the investment opportunity, in plain English. For specified offerings (See Chapter 13), it will describe the specific property being acquired. For a blind pool fund or a fund of funds (See Chapter 15), it will describe the business plan or plan of operations for the fund.
This document should be professionally designed. Its purpose is to catch the attention of prospective investors. The more professionally prepared it is, the more likely they are to be interested in the investment. The investment summary is where investors will make their buying decision. Trust me, no-one will decide to invest in your offering by reading 160 pages of legal documents!
Some attorneys will imbed the details about the investment into the private placement memorandum, but we prefer that our clients use a stand-alone marketing piece that they can show investors prior to providing the legal offering package. Investors will most likely make their buying decision when reading the investment summary, and the details about the investment could easily get lost if they are buried in a hundred plus pages of legal documents. My experience is that the attorneys who imbed business plans into the legal docs tend to charge more for their offerings than those who allow the issuer to attach a stand-alone marketing piece.
Additional Exhibits
Additional exhibits may be attached to the private placement memorandum. Their purpose is to further describe or provide additional, relevant information related to the company, the asset manager, its affiliates, and the property. This could include such things as a purchase agreement, title report, appraisal, or property inspection report. For a development project, it may include a feasibility study, entitlements, drawings or plans, etc.
Collectively, the private placement memorandum and its attached documents are meant to provide investors with all the information they need to make informed consent prior to making their investment decision. Each prospective investor should be advised to carefully review the private placement memorandum and each of its associated documents. Further, they should to be encouraged ask the issuer any questions they may have, and consult with their financial, tax, or legal advisers.
