While private placement memorandums (PPMs) were traditionally one of the most important documents in fund formation, in recent years, they’ve somewhat fallen out of favor in lieu of term sheets. If you’re a first time fund manager, you may be wondering whether you should prepare a PPM or term sheet for investors. This article will discuss trends in fund formation documents.
What Are PPMs?
PPMS are lengthy documents that describe a fund’s business model, investment strategy, and distribution waterfall. Investors can learn about how the fund plans on making money, specifics about portfolio investments, the risks of investing in the fund. Examples of clauses in PPMs include, but aren’t limited to:
- The types of investments that the fund intends to target
- Expenses that capital contributions from investors will be used for
- How profits will be distributed (for example, the 2/20 structure)
- Notices that investments in the fund will be illiquid, meaning that investors will not be able to take out their money out in the near term, or that investors may lose some or all of their money if the portfolio investments fail
Traditionally, PPMs were popular because they gave investors substantial insight into the whether investing into a particular fund aligned with how they wanted to spend their money. Why have they fallen out of favor if they contain so much useful information? Let’s explore term sheets and how they compare to PPMs.
What Are Term Sheets?
Term sheets are simpler documents that are no more than ten pages long. Unlike PPMs, they don’t describe funds in detail. Rather, they cover only the basics of what investing in funds would look like, with information listed in almost a bullet point format. For example:
- What is the amount of capital contributions that the fund is targeting?
- What is the management fee?
- What is the carry percentage?
- Are there any conflicts of interest?
Generally, term sheets don’t contain a risk section. And while much of the information covered by term sheets overlaps with that of PPMs, everything is written in much less detail. A term sheets might contain just a line or two on tax matters, while a PPM might, for example, contain at least five pages on just the ERISA implications of an investment.
Why Do Many Investors Prefer Term Sheets?
First, term sheets are easier to read. Investors may not need a full PPM if they’ve spoken to the fund manager enough to have understood the fund’s business model, investment strategy, and distribution waterfall already. Term sheets contain just enough information that investors would know how they would profit from investing in the fund.
And second, investors may want to leave some room open in case the fund decides to manoeuvre its operations. PPMs are so detailed that the fund may be locked into a particular operational strategy. Funds generally have a lifetime of around ten years, and many changes could happen in that time period. There could be an economic recession, or a collapse in a particular industry. The management team of the fund could shift, resulting in a cultural change within the fund. Term sheets are short and allow everyone to keep things flexible.
So What Should You Go With?
Because term sheets are shorter, they are much cheaper for attorneys to draft than PPMs. This means that you would save on legal expenses by testing the waters first. You can offer a term sheet first, and if any investors insist on seeing a PPM, then you can flesh out the term sheet into a PPM. As discussed earlier, term sheets are drafted in a bullet point format, so they don’t include any sentences that wouldn’t be included in PPMs. No clauses would need to be deleted.
Chances are, you won’t need to flesh out the term sheet. More and more investors are preferring term sheets over PPMs, and this trend is looking sticky.
Moving Forward
Starting a fund is a big step, and you want to make sure that you have your documents covered. To know whether investors in your particular field prefer PPMs or term sheets, try and speak with some of them to see what want. There may be specific investors you think would be a good fit for your fund who like PPMs more. In any case, it never hurts to start with a term sheet to gauge interest in your fund thesis before committing to lengthier and more expensive documents.
