Securities Offering Document Production

We assume your Company has already produced a written business plan in MS Word® format or at least convertible into the MS Word® format. If not, the following information should serve as a guideline of what you will need to produce a complete business plan to be copied and pasted into the templates, which is the first step in the production of your Company’s securities-offering document.

 

If you have a business plan, please review the following to ensure you will have the information necessary to convert it into a securities-offering document. We have embedded text needed for compliance into Financial Architect™ templates. If you Do Not have a business plan, please review the following to ensure you will have the information necessary to create your business plan directly into the securities-offering document templates within Financial Architect™. That’s right, no need to develop a business plan outside of Financial Architect™, as its more effective to build it with Financial Architect™, anyway.

 

For some entrepreneurs, the “Red Herring” document will be the first document to be produced to seek indications of interest. A Red Herring document is a summary of a securities offering document, as explained in a previous chapter with an executive summary laid out in the Private Placement Memorandum (PPM) together with the pro forma financial projections and notes thereto as exhibits. You will need to add and insert some disclaimers into the Red Herring, specifying that it is not an offer, nor a solicitation of an offer, to sell securities. Simply add this [red-colored] disclaimer to the bottom of each page of a Red Herring: “This correspondence does not constitute an offer or a solicitation of an offer to solicit or sell securities.”

 

If you have not already done so, you will need to convert the existing text-writing style in your Company’s business plan to third-party prose. If you have not, wait, we will instruct you on how to do that in the Securities Offering Document Templates within Financial Architect™ itself.

 

When producing your securities offering documentation, keep in mind most investors want answers to—among other things—seven basic questions about your Company, its capitalization plan, and the securities-offering deal structure. If you cannot answer these questions in a credible and professionally written manner within the proper securities-offering documentation, there is a low probability of you and your Management Team raising capital for your Company. (Some of this information is being repeated while accompanied with new material.)

 

  1. What does your Company do, and why is it different from the competition?

           

You can easily answer this question by inserting the correct components of your Company’s business plan into the Financial Architect™ Private Placement Memorandum (PPM) templates or by developing the correct response from your Company’s product and/or service line(s’) marketing materials.

 

 

  1. Who are you?

 

This question identifies the members of the management team. You can answer this question by including your Management Team’s background in the securities-offering document. Obviously, the more experienced management teams have a greater probability of raising the needed capital, due to the nature of their personal and professional capital contacts—potential investors that they have a pre-existing relationship with. Do what you can to form an experienced board of directors, executive-officer staff, and an advisory board. Choose a “well-networked” team not only to assist you in building the company but to raise capital as well. Make sure you have signed & dated, written engagement letters or executive compensation agreements before you add any management team member to the PPM and or before any Red Herring or PPM is distributed to any potential investor. Doing otherwise could open you up to civil litigation or criminal investigations of securities fraud.

 

Also, be careful not to compensate them for directly or indirectly selling securities though—it is illegal to do so. That means no payments should be made as a commission or bonus related to their individual efforts involving a securities offering. A non-monetary reward, e.g. a cruise to the US Virgin Islands, for the entire management team upon completion of an offering, may be acceptable, but be sure to check with legal counsel before engaging in this level of reward.

 

The CFO or VP of Finance can be compensated for other duties and responsibilities, but the function of soliciting and selling securities must be incidental to their other duties, unless their primary job is raising capital. If that is the case, the VP of Finance cannot be compensated with a percentage of capital raised; otherwise the compensation is considered a commission, which is illegal unless the sales effort is run through the books of an SEC-registered broker-dealer/securities firm. Even then, the VP of Finance would need to be licensed with that firm and working for your Company as a VP of Finance, which, for all practical purposes, would not be allowed because the broker-dealer/securities firm must ensure the VP of Finance’s compensation does not violate FINRA rules of fair practice. In other words, a FINRA Member broker-dealer/securities firm is not going to allow it. (From a FINRA compliance standpoint, it is too cumbersome.)

 

  1. What will you do with my investment?

 

To answer this question, a detailed “Sources and Uses” statement and an “Estimated Use of Proceeds” statement must be in a securities-offering document. The Sources and Uses statement serves as your detailed Estimated Use of Proceeds statement for the first year of operations, which is a required disclosure in a securities-offering document. A statement that the money will be used for “general working capital” is not sufficient. You must give details— and the more detail, the better. The pro forma financial projections you will have produced using CapPro™ contain that Sources and Uses statement that is automatically populated and calculated for this purpose. You will also need said statement for you or preferably your legal counsel to complete the “Notice of Sales” federal-and-state-filings requirement after each sale of your Company’s securities.

 

  1. How safe is my investment?

 

This question is generally difficult to answer. More often than not, entrepreneurs will attempt to sell a non-controlling interest in their firm for a substantial amount of equity capital. For instance, management may attempt to sell 20% of the equity interest in a start-up or early stage company for a certain amount of capital. For illustrative purposes, let’s say $1 million. Generally, including the entrepreneur’s cash there are no other tangible assets in the company. A sophisticated investor would realize that, by investing, he/she would immediately lose 80% of their $1 million investment due to the outstanding stock’s total-dilution factor. So an immediate loss of a major percentage of an investment, through dilution, although unattractive, must be disclosed. How safe is it? Under that scenario, not at all safe.

 

Illustrated herein and included in Financial Architect™ templates, the two most popular deal structures provide for additional elements of safety due to the non-dilutive aspect of those types of securities. Remember, the sooner you can return your investors’ capital contribution(s), the safer the illiquid investment becomes. In addition, the faster the company’s product and/or service line(s) are accepted into the marketplace, the quicker a “proven economic model” can be established, which inherently leads to higher degrees of safety of an investment.

 

  1. How do I get my investment back?

 

Exit strategies generally need to be rather quick. Although IPOs or outright sales of the entire company may seem attractive for exit strategies, those strategies cannot be guaranteed or further assured. Therefore, those exit strategies are not taken too seriously by a knowledgeable investor.

 

The two most popular deal structures (Convertible Seed Capital Notes and Convertible Participating Preferred Stock) provide for realistic exit strategies for potential investors from the securities, not the company, they invested in. Notes have maturity dates that are finite.  And although Call provisions on preferred are not based on investor rights or issuers obligations, assuming success, there’s a high probably of the preferred equity being called—bought back at a pre-determined price.

 

You may be able to attract the interest of strategic alliances—i.e., other businesses in your industry that would inherently benefit from your Company’s existence and so may provide the required equity and/or debt capital. A favorable exit strategy with a non-diluted equity position would be attractive to most strategic-alliance candidates as well as individual investors.

 

  1. If the firm fails, what are my liquidation rights and lien position on assets?

 

The deal structure of your Company’s securities offering should provide a forward or first lien position on assets for investors, which subordinate common equity in case of liquidation. In the mind of an investor, this type of deal structure further justifies taking on the risk of an investment in an illiquid security. All start-up and early stage companies are risky in the mind of the informed investor. On average, they know 50% of all start-up and early stage companies fail or stagnate within the first five years of their existence—35% of the remaining firms merely survive—providing little or no return. Therefore, you need to mitigate an investor’s risk through the issuance of non-subordinated securities and proper capitalization structuring.

 

  1. If things go as planned, what will be the rate of return on my investment?

 

Most business plans and securities offering documents do not include rate-of-return projections for the purchase of securities and/or a current, company valuation based on reasonable future financial projections, which is a major mistake. You will need to determine your Company’s current value based on realistic, future financial projections then calculate the IRR potential for an investment in your Company’s securities under 3 different scenarios; outright exit of the security; full conversion into common equity privately held; and full conversion into common equity publicly traded. Once you have produced the pro forma financial projections, you may find the percentage of equity you were willing to relinquish may be too much, for too little, in regards to the capital sought.

 

Most securities attorneys would prefer that you not project a rate of return on the securities offered by your Company. This is primarily because they fear it would increase the probability of your Company being sued if financial projections aren’t met—that is a legitimate concern. However, Financial Architect™ is based on and distinguished by the IRR projections. In most investors’ minds, that is the bottom line. The securities-offering-document templates have disclaimers that should warrant sufficient protection against litigation for not meeting those financial projections. In reality, if you do not provide IRR estimations, there is a virtually non-existent likelihood of attracting any meaningful amount of capital, which makes any increased probability of being sued “moot.”

 

Document Production

 

The PPM’s Executive Summary is macro in nature, where the PPM’s body is detailed and micro in nature. The Executive Summary would include summarizations of the main body of the PPM’s text on:

 

  1. The industry in which your Company will engage and compete.
  2. The problems or changes within that industry that provide the opportunity to profit from selling your Company’s product and/or service line(s).
  3. The solutions your Company’s product and/or service line(s) shall provide to solve those problems or address those changes.
  4. The opportunity to profit from selling your Company’s product and/or service line(s) and for investors in terms of rate-of-return projections by investing in the securities to be offered by your Company.
  5. The exit strategy for the investors.

 

By perusing the Internet, you can find securities-offering documents—aka Private Placement Memorandums (PPMs)—to use as models for your securities-offering documents. However, they may not be updated to current regulatory requirements—be sure to check with a securities attorney when you’re done.

 

From here forward, using Financial Architect™, we’ll give you just a brief summary of our process for producing a securities-offering document. Full instructions are included with Financial Architect™ End-User Instructions, within the Corporate Engineering Conservatory™.