the-anatomy-of-a-private-placement-memorandum-ppm.mp3 The PPM (private placement memorandum) is where potential investors will learn about the nuances of the deal, the capabilities of the team Listen to this article Your browser does not support the audio element.
Table of Contents
Most sponsors lure prospective investors through sleek marketing materials and the promise of high returns. This may be a way to hook people, but as they say, the devil is in the details. Behind each offering, there is often a breadth of material that outlines crucial important information.
Potential investors should read these documents carefully to ensure they understand the risks associated with each deal. This is an essential part of any high net worth investor’s due diligence process.
In this article, we take a deep dive into one of those documents: the private placement memorandum (PPM). The PPM is where potential investors will learn about the nuances of the deal, the capabilities of the ownership team, the sponsor’s experience, financial statements and more.
A private placement memorandum. Or often times referred to as a PPM, is a document used in the context of a private securities offering. PPMs are relevant to real estate when a sponsor is raising capital for a syndication. The shares of which are sold as securities in that deal.
PPMs are a quasi-legal, quasi-business risk mitigation tool. The PPM describes the offering, the sponsor’s business plan, the risks involved, provides financial statements, and more. The document lays out all pertinent information that would cause someone to invest (or not) in a real estate syndication — regardless of potential investors’ net worth.
Occasionally, people may refer to a PPM as a “Confidential Offering Memorandum” or “Confidential Information Memorandum”.
A private placement memorandum,
generally referred to as a PPM, is a document used
in the context of a private securities offering.
PPMs are rather robust documents. They will often be 50-100 pages long. Here is an overview of a PPM, or the “anatomy” of a PPM:
It’s common for a PPM to include a glossary at the beginning. This helps eliminate any misunderstanding around what certain terms mean. Especially since so many acronyms and abbreviations are used in commercial real estate.
For example, the glossary of a Private Placement Memorandum might describe what it means to be an “accredited investor”. Which is especially important if that’s a requirement to invest.
The glossary may also define the Project, Property, Prospective Investors, Sponsor, and Units.
The summary provides a quick reference for those looking for specific information. For example, it might state that the Sponsor is seeking to raise XYZ capital in order to buy the “Property” (which will have been defined in the glossary already). It will state how many shares are being offered, for what price, and the minimum number of shares that must be purchased to invest.
The summary of the offering will also include brief snippets of the more detailed sections outlined below.
This section details who is eligible to invest in the deal. Some deals are open to non-accredited investors. Others are only open to accredited investors. The PPM may include a questionnaire to help investors determine whether they qualify as an accredited investor.
Note: to qualify as an accredited investor. The potential investors must earn $200,000 annually ($300,000 with a spouse) or have a net worth that exceeds $1,000,000.
This section of the private placement memorandum will also indicate whether the investment is IRA-eligible.
The term sheet lays out the basic details of a deal’s financials. This is where, for example, a sponsor would indicate how much someone has to invest to obtain a certain percent ownership in the deal.
For example, the term sheet might say that a person is buying 85 shares of 123 Main Street LLC for $10,000 each. This equates to an $850,000 investment in the company.
The term sheet will also include basic information. Such as the going in and expected exit cap rates, the hold period, and any preferred return someone might get as a Class A shareholder. Sample financial statements may also be shown here.
The sponsor has the most significant influence on the outcome of a real estate deal. This section of the PPM will talk about the sponsor’s management team. It will describe how the company is structured, who is in charge, the experience of that team and more.
This section will also include any key third-parties that are crucial to the deal. Such as who the sponsor is using for legal, architecture, construction, property management, leasing, etc.
If any key player on the management team has a blemish on their track record, real estate related or otherwise, this is where that might be disclosed. Again, the purpose of the PPM is to provide all relevant information that may influence whether someone invests in a deal.
This section of the PPM essentially describes the sponsor’s business plan. For example, the sponsor might be in the business of acquiring value-add multifamily assets in the mid-west that it intends to redevelop into Class B+ properties.
The objectives of the company may differ depending on whether the sponsor is raising money for a fund or a specific deal. If raising money for a fund, the objectives may be stated more broadly.
PPM describes the offering,
the sponsor’s business plan, the risks involved,
provides financial statements, and more.
This leaves the sponsor with some flexibility as they pursue new deals. If raising money for a specific deal, the “Objectives of the Company” may refer to the specific LLC being used for that deal. In situations like these, the LLC formed for that deal is the “company” and the sponsor will be more explicit about the LLC’s objectives as they pertain to that deal.
The sponsor should always include basic financial statements from their company. This could be the financial statements for the real estate investment firm or for the LLC formed for this specific deal.
At a minimum, the sponsor should include a profit and loss statement and copy of the company’s balance sheet (historical and forecasted). This shows prospective investors what kind of financial shape the company is in.
It is extremely important to determine how the sponsor will receive payment. This section of the PPM details the fees that a sponsor intends to collect. This may include an annual management fee equal to a certain %; an acquisition fee, and a preferred return after achieving a certain hurdle rate.
Every Private Placement Memorandum will often discuss the entire deal structure, equity and debt included. It will outline how much debt the sponsor plans to put on the property, where that debt is coming from (a traditional lender, etc.), and at what terms. It will also talk about the equity being invested. This includes both GP and LP capital.
The “use of proceeds” section will describe how the sponsor tends to spend that money. Let’s say a sponsor is raising $5 million in equity for a $10 million acquisition. This section will describe how the sponsor intends to use the LP’s capital to execute their business plan accordingly. Most sponsors will allow for some flexibility with use of proceeds to accommodate for inevitable project unknowns.
In most syndications, the LP investors will have very little authority over the direction of the deal. However, sometimes LPs receive the right to vote under specific conditions. This section of the PPM will outline the circumstances under which a body of members can call a vote. For example, if the sponsor commits fraud, the members may choose to remove them as the GP.
The PPM will also indicate whether votes are tallied on a per investor basis or on a pro rata by ownership basis. It also specifies the minimum required vote precentage for success. Sometimes it will be a majority. In other cases, it may require a supermajority (“supermajority” will also be defined in this section of the PPM).
Some sponsors use an “off the shelf” PPM that includes generic risk factors. For example, it might state that past performance is not indicative of future performance. It might state that a downturn in the economy could adversely impact the deal and its returns.
However, sophisticated sponsors will often work with their attorneys to customize the risk factors specific to each offering. The risks may be categorized, for instance, risks related to commercial real estate investment (broadly) or this company (broadly) vs. risks associated with a specific deal.
The risk factors are critical. They must be clear and thoroughly described. This section of the PPM is perhaps the most critical section of the entire PPM. Potential investors should focus closely on this section during their due diligence process.
This section of the PPM will outline any real or perceived conflicts of interest relevant to the company, its management, or the offering. For example, someone on the sponsor’s team may be a licensed debt broker and might be taking a commission for arranging the financing. The owner of the competing property down the street might also hire the same third-party property management company.
