Does a Private Fund Need a PPM?

The short answer is no. A private investment fund (whether a venture capital fund, private credit fund, private equity fund, hedge fund, fund-of-funds or other type of non-registered fund) is not legally required to have a private placement memorandum or other offering document. Producing a high-quality PPM takes a material amount of time, work and money for a fund sponsor, many of whom are eager to avoid the exercise to focus efforts and resources on other matters. Whether a sponsor must or should prepare a PPM is driven mainly by the expectations and requirements of the potential fund investors (who can range from institutional investors and pension plans to family offices and high-net-worth individuals), rather than applicable securities laws. Many of the legal parts of a PPM can be incorporated into other fund documents, with abbreviated versions of the PPM’s commercial information covered by other marketing materials that a sponsor typically produces.

It is helpful to understand some of the securities laws that apply to the formation of a private fund. Raising a private fund is a securities offering for legal purposes, and a securities offering generally must be registered with the SEC under the Securities Act of 1933 and applicable state securities administrations or qualify for an exemption from these registration requirements. Most private funds rely on the “safe harbor” federal registration exemptions under Rules 506(b) or 506(c) of Regulation D under the Securities Act, which generally preempt state law. These safe harbor exemptions involve filing a Form D with the SEC and making notice filings in the states in which the offerees are located. A Form D is a public document that contains, among other things, basic information about the identity of the issuer and its related persons, the type and amount of securities to be sold, and the compensation payable in connection with the offering. If certain persons associated with the offering have engaged in prior “bad acts” under applicable securities laws, a Regulation D exemption may not be available to the issuer.

Private funds most often rely on the registration exemption under Rule 506(b) instead of the Rule 506(c) exemption. Rule 506(b) contemplates a private offering of securities without the general solicitation of investors. Issuers generally comply with the non-solicitation requirement by having a “preexisting substantive relationship” with each potential investor based on which the issuer reasonably believes the investor is sophisticated enough to evaluate the merits and risks of the investment. There is no limit on the dollar amounts that may be raised in Rule 506(b) offerings, but no more than 35 investors who are not “accredited investors” may participate. An “accredited investor” generally is a type of regulated institution or plan (e.g., a bank, insurance company, registered broker-dealer or investment adviser, and so forth), an individual or entity that meets certain financial tests, or someone who serves in high-function roles at the issuer. When a Rule 506(b) offering includes non-accredited investors, an issuer must provide them with information similar to what is required in registered Regulation A offerings. Given the burden of this requirement, it is rare for private sponsors to allow significant participation (if any) by non-accredited investors.

Rule 506(c) permits the general solicitation of investors, which better enables new or smaller fund sponsors to raise capital outside their network from a large number of potential investors in low denominations. That said, all investors must be accredited, and, most importantly, the issuer must take reasonable steps to verify each investor’s accredited status. If the issuer verifies directly, it must request and analyze one or more of an investor’s tax returns, bank records, brokerage reports and financial statements. Investors often are unwilling to provide this information to sponsors, while sponsors do not want to safeguard it, undertake a verification process and analysis, or take the associated risk. Alternatively, an issuer may rely on an accredited investor certification from the investor’s lawyer, broker-dealer, investment adviser or accountant, who presumably must review the same types of information. Many advisors will not provide a certification, and investors do not want to pay them to do so.

All securities offerings, whether public or private, must comply with anti-fraud requirements. When providing information about the offering, an issuer must not make a material misstatement or an omission that makes other statements materially misleading.

While many sponsors view a PPM as a sales tool, their lawyers see it as a means to mitigate liability and comply with the anti-fraud requirements. A typical fund PPM does some of both and includes sections containing or addressing some combination of the following: an executive summary; a summary of the fund’s material terms; a description and history of the sponsor, its personnel and its investment strategy; the sponsor’s identified industry and market opportunity; the sponsor’s investment criteria and process; case studies of example investments; financial performance of the sponsor’s prior funds or investments; risk factors; conflicts of interest; regulatory considerations; tax considerations; and security notices and disclaimers. A potential investor is often given a copy of the PPM, a subscription booklet (which contains a subscription agreement to evidence the purchase of an investment in the related fund and a robust questionnaire to obtain information the sponsor needs for regulatory purposes and compliance), and the fund’s limited partnership agreement.

Some institutional investors expect to see a PPM, and it can represent a “checklist item” in their underwriting and evaluation. Nascent sponsors also may have a greater need for a PPM to inform and educate potential investors about their platform and strategy. Established sponsors with repeat investors have less need for a PPM. Investors who are smaller family offices or high-net-worth individuals may not expect or want a PPM.

The benefits of a PPM can be realized through alternative and less formal or expensive means. For example, it is common for a sponsor to have a “deck” that conveys key information about the fund investment opportunity. This deck (with appropriate legal review) can be paired with a more robust subscription booklet that contains the “legal wrap” portions of a PPM — the summary of key terms and sections for risk factors, conflicts of interest, regulatory and tax matters, and security notices and disclaimers. The deck satisfies the sponsor’s commercial objectives, while the booklet addresses the lawyer’s concerns about risk, liability and compliance. This combination can be more time- and cost-efficient than preparing a PPM.

Before a sponsor assumes they must dedicate time, money and resources to producing a formal and lengthy PPM, they should consider whether such a document is needed for their specific facts and circumstances. In many situations, they may be able to accomplish their capital-raising objectives (while still satisfying applicable legal requirements) with something less. To assess whether to produce a PPM or take the less formal approach described in this post, and for assistance with preparation and review of related documentation, please reach out to one of the attorneys in our Fund Formation & Investment Management group.