650 Page Mill Road
Palo Alto, CA 94304-1050
To: Private Equity Fund Clients
From: Fund Services Group
Date: April 12, 2007
Re: Due Diligence in the Preparation of Private Placement Memoranda
Often, when a venture capital or other private equity firm (a "Firm") prepares the private placement
memorandum (the "PPM") for a new investment fund, only a subset of the Firm's members will actively
participate in the PPM drafting and review process. This memorandum briefly highlights the risks of that
practice and suggests that a Firm always follow internal due diligence procedures to ensure that the PPM is
Most venture capital and other private equity funds ("Funds") are marketed primarily by means of a
PPM. Each PPM typically contains three sections:
1. A business/marketing section, designed to explain to prospective investors the nature of the
Fund's investment opportunity, the strategy the Fund is expected to employ in order to exploit the opportunity,
and how the Firm's team of investment professionals is qualified to implement the strategy in order to exploit
2. A summary of the Fund's principal business terms.
3. A disclosure section, typically including various legends, discussions of business and legal
risk factors, and other pertinent information.
Most often, the business/marketing section is initially drafted by members of the Firm and reviewed
by legal counsel, while the summary of principal business terms and disclosure are initially drafted by legal
counsel and reviewed by the Firm. One of the most important purposes of each review is to ensure that the
PPM, taken as a whole, is not misleading to prospective investors.
Under United States securities laws governing private placements, a PPM is not required to provide a
thorough discussion of every consideration that may be relevant to a prospective investor. However, with
regard to those considerations that are discussed, the information provided must not be misleading.
It is important to note that omitting information can be just as damaging as an affirmative
misstatement if, by virtue of the omission, the information presented in the PPM is rendered misleading. For
example, if a PPM presented the investment track record of the Firm's investment professionals, but failed to
mention several investments with poor returns, and furthermore failed to notify investors of the omission, the
track record portion of the PPM may be misleading even if all of the information presented were technically
April 12, 2007
A misleading PPM might result in liability for the Firm and its members, and possibly even
dissolution of the related Fund. 1
Many Firms designate only a subset of their members to draft, review, and interact with the Firm's
legal counsel regarding the PPM. Unless all relevant members of the Firm participate in this process, there is
a risk that material information known to non-participating members will be excluded from the PPM, thereby
causing it to be misleading to prospective investors. 2
Example: Venture capitalists A, B and C are the managing directors of the venture Firm ABC. A is
the most senior and experienced of the managing directors, and has an excellent reputation based in part on
her continuing role as acting CEO of WidgetCo, ABC's best-performing portfolio company. Due to the
demands on A's time, B and C are designated to handle preparation of the PPM for ABC's upcoming Fund. B
and C work with the Firm's legal counsel to prepare the PPM. Unknown to them, however, A has come under
investigation for allegedly directing WidgetCo contracts to her brother-in-law and likely will be forced to
resign from her position as acting CEO within a few months after the Fund's initial closing.
Based on the facts in this example, it is possible that the PPM would be misleading if it failed to
disclose A's changing relationship with WidgetCo. There are, however, many reasons why A may fail to
warn B and C in time, ranging from A's focus on other matters through A's concern that disclosure might
breach A's fiduciary duties to WidgetCo. Whatever the reason, the degree to which the PPM discloses issues
relating to A's relationship with WidgetCo should be made consciously by the ABC Firm in consultation with
its legal counsel – not by default simply because the Firm members working on the PPM are unaware of the
issues' very existence. 3
Issues to Look For Upon Review
In general, a PPM should neither overstate the potential benefits nor understate the risks of investing
in the related Fund. Potential issues that may be identified in reviewing a draft PPM include the following:
1. Overstatement of the investment opportunity, whether in terms of the availability of target
companies, the Fund's access to deal flow, overall market/technology conditions, or other attributes.
While the focus of this memorandum is upon the PPM, Firms should of course exercise care in the preparation of all
marketing and related materials (e.g., brochures, "pitch decks," and responses to due diligence questionnaires) provided
to prospective investors. For additional information, please see our memorandum to clients titled "Supplemental
Marketing and Due Diligence Materials."
Exactly who will be the "relevant" members depends upon the facts and circumstances. In general, though, the
relevant members will be those members identified in the PPM as participating in the management/operation of the Fund
as well as, if not otherwise identified in the PPM, the Firm's chief financial officer.
It is possible that a Firm member may have a fiduciary or other duty to refrain from disclosing certain types of
information to the Firm in connection with the preparation of a PPM. The member may require the assistance of his or
her personal legal counsel in determining how to inform the Firm of the existence (if not the details) of information that
may not be disclosed. Under rare circumstances, a member's inability to disclose material information may preclude that
member's participation in the related offering of Fund interests.
April 12, 2007
2. Overstatement of the investment team's qualifications, whether in terms of time commitment
to the Fund, investment track record, prior experience, education, relationships with important third parties, or
3. Confusing or improperly labeled financial data. Common problems include failing to
distinguish: (i) gross from net investment returns; (ii) valuations of private companies from valuations of
public companies; (iii) realized returns from unrealized returns; (iv) valuations based upon the Firm's
estimates from those based upon objective arm's length events; and (v) complete listings of prior investments
from mere samples or highlights.
4. Understating risks, whether they relate to the types of investments expected to be made, the
jurisdictions in which portfolio companies are expected to operate, instabilities in the investment team, or
5. Failure to disclose adverse facts relating to the investment team, whether they relate to
expected or pending lawsuits, governmental actions, non-competition or other effectiveness-limiting
agreements, conflicts of interest, recent or impending departures of key personnel, removals from prior
positions, disputes with current/former limited partners, or other adverse facts.
Typically, the key questions to ask in reviewing a PPM are:
1. With regard to the particular issue under review, is the overall presentation of that issue in the
PPM, taking into account all of the information provided, misleading? Has information necessary to prevent
the presentation from being misleading been omitted?
2. With regard to any presentation that may be misleading, would a reasonable prospective
investor consider the missing/misstated information to be material to their investment decision?
Prior to completing any PPM, a Firm should circulate the final draft to all of its relevant members and
require that they confirm, to the best of their knowledge, that the PPM would not be misleading to prospective
investors. A sample confirmation form is attached hereto as Exhibit A.
This memorandum is intended only as a general discussion of the information presented and should
not be regarded as legal advice. For more information, please contact your Fund Services Group attorney.
DUE DILIGENCE CONFIRMATION FORM
General Partner Name:
PPM Draft Date/Version Number:
Each of the undersigned hereby confirms as follows.
1. I have reviewed and understand the Wilson Sonsini Goodrich & Rosati memorandum titled "Due
Diligence in the Preparation of Private Placement Memoranda."
2. I have reviewed the draft PPM indicated above and confirm that, to the best of my knowledge:
a. The draft PPM, taken as a whole, would not be misleading to a prospective investor of the
type expected to participate in the Fund; and
b. Except as otherwise expressly disclosed in writing to the attorneys directly assisting in the
preparation of the PPM, I am not: (i) subject to any pending or threatened lawsuit, investigation or
governmental/regulatory action; or (ii) otherwise in possession of information that both (x) is not reflected in
the PPM and (y) should be reflected in the PPM in order to prevent the PPM from being misleading to a
prospective investor of the type expected to participate in the Fund.
This Due Diligence Confirmation Form is intended solely for the use of the General Partner and may not be
relied upon by any other individual or entity.