Offering memorandum- Protecting the interest of issuers and private placement investors

An offering circular (OC), also known as Offering Memorandum (OM), is a legal document that contains the potential, risks, terms and objectives of an investment which is involved with the private placement. This financial prospectus includes items such as, detailed and comprehensive description of business, management biographies, financial statements etc. Basically, it aims to provide complete information to the buyers on the offering. It further protects the sellers from the cumbersome liability linked with the selling of unregistered securities. They are also called “private placement memorandum” or PPM. They are essentially required to be used in a “private offering”; a sale of securities or stock between the various private parties.

As opposed to a public offering, the legal document acts like a (finance) prospectus for a bond or any other type of security for a private dealing. Instead of using the term “prospectus”, in some situations, it is known as offering memorandum. When the offer of a bond is not required to be registered with the U.S. (United Nations) Stock exchange Commission, the terms “offering circular” or an “offering memorandum” are used. Both the offering Memorandum or PPM and prospectus share many related attributes but the types of disclosures and terms and conditions of amount needed are different. Further, it consists of a “subscription agreement”, a formal contract between the potential investor and an issuer for the investment purchase.

For example, a private company, XYZ, operates a chain of parlours. It is seeking to raise $30 lakh capital for opening more parlours, but it does not want to borrow or go public. So, XYZ Company decides to sell the equity through private placement to the investors.  To comply with the federal and state securities law, as well as to educate the potential investors, XYZ Company writes an “OM”. It circulates the same to all the interested parties.  The offering memo informs about the terms of the offering transaction (like the amount of minimum investment, investor qualifications), risk factors (like tax issues, potential returns, litigation, vulnerabilities, issues of transferability), a summary of the business plan, management summary, capitalization structure, financial forecasts and other such information.

Now the question that is frequently asked is that: Is it imperative to provide a potential investor with an offering memorandum when going in for a private offering? The answer is a simple “yes”. It should be circulated for 3 major reasons-

  1. The legal document clearly specifies that what exactly you are offering to a potential investor. The investor will be in a position to understand the potential returns, the reasonable risks, the terms, the stock type, the capital structure etc.
  2. It adds protection for the investors as well as securities issuers. The issuer will adequately comply with the required SEC rules as well as regulations.
  3. A memo looks more formal and it will simply impart a professional look to the offering. It highlights the seriousness of the securities issuer towards the SEC compliances, attitude towards the investors and about receiving the private capital.