With startup activity on the rise, it's becoming more common for entrepreneurs to seek funding from third parties in order to turn their startup dreams into reality. Unfortunately, needing cash and jumping right into fundraising don't work in perfect tandem. There are important housekeeping steps to take before seeking capital, including getting a handle on your business' capital structure, ensuring proper documentation of even the most basic transactions, and clearly defining how you'll use the funds you raise.
Once those ducks are in a row, there is one especially crucial step to remember--and one that can often be overlooked due its high cost: preparing private placement memorandums (PPMS), or disclosure documents for private offerings. The PPM describes your company, the terms of the offering, and the risks of the investment, amongst other things.
Georgia Quinn, CEO and Founder of the newly launched iDisclose, an on-line application that generates institutional grade PPMs at a fraction of the time and cost, explains exactly why disclosure documents should never be an overlooked step in your business plan:
"Life happens," says Quinn, "In third-party relationships (outside of friends and family), PPMs protect you in case something goes wrong with an investor." Quinn went on to explain that though investors aren't malicious (they love you!), unexpected life events can cause them to re-evaluate assets. And in certain cases, this can lead to an investment retraction. In many cases a lawsuit ensues.
As a startup, it's likely that you've already used the invested funds to benefit your business, which means you can't just give back an investor's money on request. And when that happens, the investor has the power to file a suit against your company, based on any possible holes in the information you disclosed before taking their money.
According to Quinn, there are one of two things you can do in these situations:
"You can either prove proper disclosure with the PPM you had the good sense to prepare, or you can be left to fight empty-handed because you never created one," she says.
The purpose of a PPM is to lay out everything an investor needs to know about your business, including all the risks, before deciding to hand you any of their money. When an investor signs a subscription agreement, they're acknowledging that they made an informed decision based solely on what's outlined in your disclosure documents, not what you've verbally stated and not what anyone else has told them. With a well-written PPM in place you're covered if they ever come knocking.
I've seen many, many (probably most) founders accept six-figure checks from investors with only the most basic legal documentation in place. It's not uncommon that they run into serious issues a year or two down the road as a result. Again, investors are not malicious, but they are savvy business people. You never know if or when they may decide that their investment will work better for them elsewhere.
Now that you understand the importance of protecting yourself with proper disclosure documents, you can learn more from Quinn about how to stand out in the eyes of investors.