A prospectus is an official document filed with the Securities and Exchange Commission (SEC) that offers details about an investment being offered to the public for purchase.
What Is a Prospectus?
The prospectus is a legal document that a company files with the SEC, related to that firm's security offerings. The filing contains information about the company, the management team, financial performance, and any other details pertinent to an investor. The prospectus is designed to be the place where investors can obtain the information necessary to decide on potential investments, such as buying a stock. Along with pertinent operational and financial information, the prospectus contains key disclosures about the investment's risk so that investors can make an informed decision.
Bond & Stock Prospectus
When a stock or bond is going to be offered in an initial public offering, a preliminary prospectus helps attract investors to the new investment. The preliminary prospectus has all the financial data but doesn't include the number of shares or the stock's issue price. It is really just a way to gauge market interest.
Once the market has been tested, and the IPO price is set with the final number of shares to hit the market, the final prospectus is completed and distributed to potential investors.
Mutual Fund or ETF Prospectus
The mutual fund or ETF prospectus is the document that explains to investors what the investment strategies and objectives of a specific mutual fund are. It reviews management details, a list of top securities, financial information, and past performance results to help the investor determine whether the fund meets the investment objectives.
Note: Companies are required to provide a prospectus for a newly issued investment securities. Investors should review the document thoroughly before investing.
What a Prospectus Includes
A prospectus is intended to be a comprehensive document that can supply an investor with enough information to make an educated decision about an investment security. It is a key part of an investor's due diligence on new stocks, bonds, and mutual funds.
In the prospectus, investors will find:
Company's Business Model: This explains how the company proposes to make money and turn a profit. This section lists the products or services the company sells.
Company History: Provides a background about the company to help investors understand its historical success over time.
Company Financial Details: Investors should be able to get a clear picture of the financial gains or losses that the company has experienced in recent years.
Risks: The risks are the items that could cause the stock, bond, or mutual fund to perform below expectations.
Total Shares Being Offered: Only a final prospectus definitively lists the total number of shares offered in an IPO, and at what price.
How a Prospectus Works
A prospectus is required to be filed when new shares are offered for a company. This can be an IPO of a stock or the ongoing new creation of shares in an open mutual fund. The prospectus can be created internally by the company's legal and accounting teams, or an underwriter can create it. The underwriter is an investment bank hired to launch the IPO. Companies are legally responsible for distributing the prospectus to anyone interested in investing in the security so they may review the opportunity and risks.
4 Types of Investment Prospectuses
Investors may encounter different prospectuses when considering a new investment.
1. Deemed Prospectus
The Companies Act of 2013 created a deemed prospectus. This is any document that approves of or offers securities to the public even if it has not been officially registered with the SEC.
2. Red Herring Prospectus
A red herring prospectus may also be referred to as a preliminary prospectus. It must be filed with the registrar before the offer is made. It contains all required information about the company, its management, and financials but doesn't have a specific price or quantity being offered.
3. Abridged Prospectus / Final Prospectus
The abridged prospectus is the prospectus with salient changes made to the document that include updated financial history, promoters, and an offer for sale. With the number of shares and the specific price per share, the abridged prospectus is also known as the final prospectus.
4. Shelf Prospectus
A shelf prospectus is issued when a company offers more than one type of security. For example, it may offer common stock, preferred stock, bonds, and warrants. The shelf prospectus reviews all securities that the company plans on presenting to the public for investment.
Companies are going public all the time and issuing preliminary and final prospectuses. In 2018, Apple Inc. filed this prospectus related to a $7,000,000,000 bond offering. It includes 5 different securities with different maturity dates and/or coupon rates.
Apple's above bond prospectus contains a lot of information, including the following:
- A list of notes offered
- The issue date and maturity dates
- The interest rate on the notional value
- Optional redemption conditions
- How Apple place to use the proceeds
- Risks for investors
Apple's 2018 bond prospectus is a long document, but by no means the longest. Many prospectuses exceed 100 pages. A prospectus is designed to be comprehensive so that investors can appropriately understand the opportunity and the risk.
Reading a Prospectus as an Investor
Investors should carefully read the prospectus to understand the investment risk and potential growth fully. Investors who are not familiar with the company should read key details about the issuing company's products or services. Investors may want to look for a company that has the potential to fill a need for a large demographic segment or capture a significant market share of an existing product.
Management should have the experience to run the company and grow it in its sector. Financials are tricky as many growth companies have a history of losses because the company has invested everything into growth and development. It can be risky to invest in companies losing money but these companies are seeking capital to grow and scale in order to become profitable. This is why understanding the use of proceeds is imperative. It is important that the investor read through the risks of the company to get a big picture understanding of what could derail the investment from growth.
The prospectus is the document that gives the pros and cons of investing in a particular stock, bond, or mutual fund. It lists the investment objectives and reviews key financial and operational data about the company. It also reviews the risks of the investment so that investors have a comprehensive view of it.
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