Have you ever wondered why you need a confidential Private Placement Memorandum signed by potential investors when you are looking for investors to invest in your business?

Look no further than the California Court of Appeals in WA Southwest 2, LLC v. First American Title Ins. Co., _____Cal. App. _____ (Cal. App. 4th Dist. Sept. 4, 2015).

The court in WA Southwest found that the plaintiff investors had to plead and prove that they used “reasonable diligence” in order to prevail on claims that they were misled about the true nature of their investment. When the plaintiff investors signed purchase agreements for their
investment, they also reviewed and signed the confidential Private Placement Memorandum. It repeatedly warned potential investors about the risks inherent to the investment including this representative example quoted by the Appellate Court:
“THE INTERESTS AND INVESTOR UNITS OFFERED HEREBY ARE HIGHLY SPECULATIVE. AN INVESTMENT IN THE INTERESTS OR INVESTOR UNITS INVOLVES SUBSTANTIAL INVESTMENT AND TAX RISKS.”

“THE PURCHASE OF INTERESTS AND INVESTOR UNITS INVOLVES SIGNIFICANT RISKS. INVESTORS MUST READ AND CAREFULLY CONSIDER THE DISCUSSION SET FORTH BELOW IN ‘RISK FACTORS.’”

“PURCHASE OF THE INTERESTS AND INVESTOR UNITS IS SUITABLE ONLY FOR PERSONS OF SUBSTANTIAL MEANS WHO HAVE NO NEED FOR LIQUIDITY IN THEIR INVESTMENT.”

The Court found that reasonable diligence did not include “ignoring a private placement memorandum received prior to making an investment.”

Before you solicit investors for your enterprise you should consider this issue and make sure your Private Placement Memorandum contains the appropriate language. The language in the investment offering documentation, including the Purchase Agreement and Private Placement Memorandum, may ultimately be what saves you and your business, and gets you out of court if you end up with disgruntled investors.

The information presented is not intended to be, and does not constitute, “legal advice.” Because each situation varies, and only brief summary information is provided here, you should not use this information as a basis for action unless you have independently verified with your own counsel that it applies to your particular situation.