COVID-19 Risk Factors Belong in Your Private Placement Memorandum
The COVID-19 pandemic will have lasting unknown effects on businesses and has already caused delays and cancellations with respect to fundraising efforts and investment transactions planned or already in progress. Although raising capital during a pandemic seems like an impossible task, there are investors and issuers that are carefully progressing through the process of pitching, conducting due diligence, negotiating terms, and even closing rounds of financing. Issuers and investors fortunate enough to move forward on their transactions will have some additional considerations to mull over as they negotiate terms and determine an appropriate valuation for a company at a time when the global economy appears to be on the brink of collapse.
This post will discuss the need for companies thinking about fundraising in a private offering of securities to make additional disclosures to prospective investors regarding the impact of the COVID-19 pandemic.
For non-reporting companies conducting a private offering of their securities to investors, disclosures about how the COVID-19 pandemic has and will continue to impact the issuer should be made in a private placement memorandum (PPM). A PPM is the primary disclosure document provided to prospective investors in private offerings of securities to help investors make an informed decision regarding whether to invest in a particular business. Generally, a PPM will provide information about the issuer, the securities to be issued, the issuer’s business, operations, and the advantages, disadvantages, and most importantly, the risks associated with the issuer and thereby the securities the investors intend to purchase. The COVID-19 pandemic will have a material adverse effect on the global economy and on many businesses. A failure to disclose or adequately describe the investment risk it poses may be a material omission or misstatement that could allow investors to have claims for damages or even rescind their investments.
Not all issuers will be affected equally by the COVID-19 pandemic. For many businesses, the impact of the pandemic will be far reaching and substantial, but it may not be material for others. This is why the risk factors disclosed in PPMs should be specifically tailored to address the issuer’s own unique, or not so unique, set of circumstances. Issuers and investors alike will be confronted with challenges caused by disruptions in the consumer marketplace, government regulations and restrictions in response to the pandemic, and other unknown changes in federal and state law. Disclosures should be made around the significant uncertainties regarding the effect of the COVID-19 pandemic on different aspects of the issuer’s business, such as labor and employment matters, supply chains, distribution and customer demand, and the short and long-term negative impact on the issuer’s operations, financial condition and projections.
Labor and Employment
In addition to the usual risk factors around hiring employees and/or independent contractors such as workers’ compensation, wage and hour compliance, availability of highly skilled workers, immigration laws, harassment claims, and management issues, the COVID-19 pandemic will likely have a major impact on hiring, retaining, paying, and managing workers. Shelter in place orders mean that non-essential businesses are forced to operate almost entirely remotely which will prove challenging for even the most tech-savvy and remote-friendly companies. Essential businesses that still operate during the pandemic must put into place and enforce social distancing policies, and may have additional liability if an employee contracts the virus at the workplace.
The COVID-19 pandemic will likely have some sort of impact on an issuer’s supply chain. This might be in the form of delays in shipments of supplies, key vendors temporarily ceasing operations, service providers unable to perform their duties in a timely fashion, or distributors and sales teams unable to sell and market the issuer’s products. This could or may already have a negative effect on the issuer’s financial condition.
Closures for Non-Essential Businesses
It will be important to determine if the issuer is deemed an “essential business” in the jurisdictions in which it operates. Whether it is or not should be disclosed. Additionally, an issuer should have a general plan for how operations will continue during and after the pandemic. For businesses that are non-essential and require on-site activities (manufacturing, in-person service providers, etc.) it may prove impossible to carry on operations as normal and there are unknown risks and restrictions for future operations.
Demand and Market Downturn
The COVID-19 pandemic will likely have an adverse effect on the global economy as a whole, resulting in an economic downturn that could impact demand for the issuer’s products or services. Likewise, issuers should let investors know if they are in a position to take advantage of closures or other impacts of the pandemic, for example businesses offering medical supplies, remote collaboration technologies, or delivery services may see an uptick in demand and revenue.
Federal, state and local governmental authorities have passed legislation and issued rules and executive orders aimed at blunting the economic impact of lockdowns and shelter in place orders to workers and businesses alike. The costs of such measures such as mandated paid sick leave may be borne solely or partially by businesses, which may have a material adverse effect on their financial condition. Uncertainty around how long the pandemic will last and its continuing effects on the economy may result in further government actions that could adversely impact the business and financial prospects of the issuer. Issuers are advised to monitor new legislation or orders to which they may be subject and assess how such government actions may impact their business. If the issuer’s business will be or might be materially affected, appropriate disclosures to investors should be made.
An issuer may either (1) revise or update its existing risk factor disclosures in its offering materials to address how each area has been or may be affected by the COVID-19 pandemic, or (2) include a new standalone risk factor disclosure regarding the COVID-19 pandemic and its impact on the issuer’s overall business. Either way, it is important to be fully transparent about the pandemic’s effect on the business of the issuer. Because of the rapidly changing nature of the pandemic and government and societal reactions, it is important that an issuer monitor these developments and their impact on its business and update its disclosures as circumstances change.
Issuers or investors with questions regarding COVID-19 risk factor disclosures may contact any member of Wendel Rosen’s Business Practice Group.