Balancing Act

An Even Hand

According to Yankowitz, many entrepreneurs provoke legal action because they do not present an evenhanded scenario in their primary sales document, the private placement memorandum (PPM).

Take, for example, the Chinese theory of market penetration-which, unfortunately, many entrepreneurs use in their business plans and PPMs. It goes something like this: If there are 1 billion people in China, there must be 2 billion ears. If we're selling earrings at $1 each, with a 50 percent operating margin, then market penetration of just two-tenths of 1 percent will yield an operating profit of $1 million. One percent penetration yields profits of $10 million . . . and so on.

The problem with these kind of futuristic scenarios, Yankowitz cautions, is they don't show the other side. "Sure, places like China represent a great opportunity," he says, "but there are also tariff and nontariff barriers, political risks, currency risks, perhaps well-organized competition, and, in many instances, technical considerations."

What can and does happen, says Yankowitz, is that if the company does not take off and there are a lot of angry investors, the PPM can work against you. "If your document is highly promotional in nature," he says, "it begins to look bad in court."

The key to protecting yourself, Yankowitz says, is to exercise restraint in your description of the upside and use an abundance of caution when describing the risk factors and investment considerations. Typical risk factors that many companies face-and hence talk about in their PPMs-are limited or no operating history, reliance on pending patents that may not be granted, reliance on patent protection, reliance on one or two key employees, competition, need for additional financing, and the absence of liquidity in the investment.

"To give them some ideas and boundaries, I counsel clients to get initial public offering (IPO) prospectuses for similar companies and see what risks they are disclosing," says Yankowitz. If restraint is too subjective a criteria for you, he says, "as an operating guideline, do not write in your PPM or utter a single sentence that you cannot back up and provide a reasonable basis for."

Like this article? Get this issue right now on iPad, Nook or Kindle Fire.

This article was originally published in the February 1996 print edition of Entrepreneur with the headline: Balancing Act.

Loading the player ...

3 Keys to Getting Better, More Restful Sleep

Ads by Google

Share Your Thoughts

Connect with Entrepreneur

Most Shared Stories