Understanding a prospectus

A prospectus – what exactly is it?

In short, a prospectus is a legal document that informs the public and potential investors about the planned release of a new security which could be anything from stocks and ETFs (exchange traded funds) to mutual funds and bonds. The prospectus will reveal information about the company that investors will want to take into account before they potentially invest in the security. 

The prospectus will contain information about facets like the management team of the company, financial performance, potential growth and more that will help investors to make better decisions with regards to their risk tolerance. The SEC (Securities and Exchange Commission) requires companies to submit this document before going public with their security. 

How a prospectus works

We know what a prospectus contains but how does the process actually work? Well, a company will first need to submit a preliminary prospectus which is filed before the company plans to take their security public. 

This preliminary prospectus is basically used to gauge the temperature of interest from potential investors. The preliminary prospectus is the one that will contain all of the information about the company for potential investors to take into account. However, it will not contain information like how many outstanding shares will become available or what the starting share prices will be. 

When the company feels they have enough information, they will then file their final prospectus when their security is actually ready to officially go public. The final prospectus will contain all of the relevant information about pricing and share volume that the preliminary prospectus left out. 

It’s worth noting that companies will file a prospectus to also share information about some of the risks involved with purchasing their security. It’s important that they do this to some degree as the prospectus is actually there to also protect companies from any claims that they did not fully disclose pertinent information about their financial status or potential growth. (1)U.S. Securities and Exchange Commission."What Is a Registration Statement?"

Types of prospectuses

We have touched on the fact that companies need to issue a preliminary and final prospectus before they can take their security public. However, there are actually a number of different types of prospectuses. Let’s take a brief look at some of the different types of a prospectus that one can find. 

An abridged prospectus: in short, one could call this a “summary prospectus.” It is basically just a reader-friendly document that contains the information of the company and its security in simpler terms. 

A deemed prospectus: there are times where a company may opt against selling their securities directly to the public. If this is the case, they will use an issuing house to handle the task of issuing their prospectus. This would be known as a deemed prospectus.  

A mutual fund prospectus: as the name suggests this is based on mutual funds or ETFs. The mutual fund prospectus will issue information on the fund’s overall objectives, investment strategies, past financial performance, the distribution policy of the funds, potential risks and information on the management team. `

A shelf prospectus: a shelf prospectus is when a company issues a prospectus that contains information on several different securities, all at once. This is also known as “shelf registration.” The “shelf” in the name refers to the shelf life of the prospectus, as it generally only lasts for a year. 

A statutory prospectus: one could consider a statutory prospectus to be a mixture of the abridged prospectus and the mutual fund prospectus. This is because it provides a summary of ETF or mutual funds securities but in much greater detail. 

The varying components of a prospectus

We have briefly touched on some of the information you can find in a prospectus but there are several other factors to consider. In addition to some of the points we have touched on, let’s take a look at some of the other key components that you can find within a company’s prospectus. By knowing what the components of a prospectus are, you will be better equipped to read and understand them. 

General overview and history: as we noted earlier, a company will include information on their history and some of their past accomplishments as a company as well. This will include what strategies have helped them achieve success in the past, what their financial history looks like and what the unique selling point of the company is that helps them stand out from the competition. 

Financial information: a company may then include a closer look at financial performance over a specified period of time. This could include things like stock performance and the gross and net profit of the company in that time. 

Deal structure: you will typically find that companies who have issued securities in the past will make sure to add this in their future prospectuses. The prospectus will include information about the capital structure of the company with details on the company’s debt, equity and how investor participation will impact the deal structure. It will also make it clear what the company would ideally like their future capital structure to look like as well. 

Information on management: on a more basic level, the company will include information about their higher level executives in the company, where they received their education and qualifications from and how the executives seek to protect the company’s investments. 

Securities offering: the prospectus will detail the two types of securities that a company can offer investors, namely debt securities and equity securities. This additional round of potential investment will be detailed in the prospectus and will show what the potential rates on the securities will be. 

Risk potential: a company’s prospectus will also include any risk potential of investing in the security. This will show the investor what issues they may face with regard to government regulations or capital restrictions. 

Products and services: this part is fairly basic, it’s simply where the company will highlight what they may include to sell to the public. 

Plan for capital intake: this will be a detailed look at what the company plans to do with the investments it receives for its security once it goes public. This could include what new products it intends to finance or what it plans to expand the company. 

Prospectus FAQs

How does a prospectus serve the public?

A prospectus is vital for potential investors in the public as it gives you crucial information about the company that is about to issue a security. Not only do you receive information on the previous financial standing of the company but you also receive information on potential risks of purchasing the security they are about to go public with. 

Is there more than one kind of prospectus?

Yes, for the most part you will typically be dealing with a preliminary and a final prospectus. However, as we mentioned earlier on, there are varying degrees of a prospectus when used for things like ETFs. mutual funds or for limited periods of time. 

Who regulates these prospectuses and can they be trusted? 

All company prospectuses in the US are regulated and filed by the SEC. No company in the US can issue a public security without going through the SEC first with their preliminary and final prospectuses. You can trust that the SEC has rigorously combed through these prospectuses to ensure the information is accurate.


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