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Financial Literacy

What is a Prospectus?

When new companies prepare for an IPO or established companies seek to issue new equity, they need to file a prospectus. This is a legal document provided to investors interested in a financial security, who need to make an informed decision. It contains information about business operations, financial statements, operations results, risk factors and management. Audited financial statements are also included. 

The Securities and Exchange Commission (SEC) requires every company issuing equity to file a prospectus, and to ensure their document matches uniform standards and criteria. Why? So investors can easily get information and learn more about a company or fund before they make an investment.

Going over an investment prospectus

The Purpose of a Prospectus

A prospectus is a tool for investors. It provides a consolidated, top-down, historical view of a company or fund, to contextualize a new equity offering. Any time a company offers new shares of stock or issues new bonds, it must file one with the Securities and Exchange Commission as part of due process. Investors can evaluate the filing to understand exactly why a company has chosen to pursue additional investor capital. 

A prospectus is also a risk management tool. Companies need to provide best- and worst-case scenarios as part of SEC-mandated data inclusion. This helps investors better-understand the full scope of expectations, and to set theirs accordingly. It’s an opportunity for companies to disclose risk factors, and for investors to decide for themselves if they have the appetite for that risk.

Finally, like all formal filings, an investment prospectus is a paper trail for companies. It provides protection against claims of fraud or accusations of misleading investors. 

What’s Included in an Investment Prospectus?

These documents are incredibly important, and the information contained within them is subject to broad scrutiny from the SEC, investors and third-party auditors. As such, they include anything pertinent to the company and its decision to issue equity. Some of the high-level topics covered in an investment prospectus include:

  • Company name, summary and history
  • Information about proposed securities
  • Management/principal biographies
  • Audited financial statements
  • Best- and worst-case scenarios
  • Relevant investor information

A prospectus isn’t limited to this information, specifically. Many also include the names of underwriting financial institutions, audit partners, statements of risk and more. Again, prospectus filings need to meet rigid SEC delivery requirements. They’re also required for both public and private offerings.

Two Types of Investment Prospectus

There are two types of prospectuses a company will file on the path to issuing new securities: preliminary and final. As the names suggest, they’re both filed in sequence throughout the process of issuing new stocks or bonds.  

The Preliminary Prospectus: A Red Herring

A red herring is a literary device that misleads readers. And it jokingly refers to a company’s preliminary filing, thanks to the red lettering on the cover. Companies use a preliminary prospectus to shop an equity deal among institutional investors—and to eventually move forward with a public offering. It’s a basic overview of the company and its proposed equity offering, with best- and worst-case scenarios attached. 

The Final Prospectus: Ready for Market

A company’s final prospectus includes everything from its preliminary prospectus, plus the final security information, including quantity and pricing. It’s a more complete version of the earlier filing. The final is what investors will see when the plan to distribute new equity goes public. It’s also what they’ll review to discern whether they want to participate in the investment. 

The biggest difference between the two is that the latter includes relevant information about new securities. The preliminary filing lays the groundwork for buy-in; the final prospectus consolidates information about a done deal for investors. 

What is a Mutual Fund Prospectus?

Companies aren’t the only entities that must produce a prospectus—mutual funds need to file these documents as well. Mutual funds continually release new shares, which makes these filings different from a traditional investment prospectus. Mutual funds need to file new documentation annually to stay compliant with SEC standards. 

The document itself is also slightly different from what a company might file. Alongside historical information and management principals, these filings also include the objective of the fund, investment strategy, distribution policy and fund manager biographies, as well as fees to fund holders. They serve the same purpose: to inform potential investors.

What is an Abbreviated Prospectus?

There can come a time when an established company needs to seek investor capital or change the structure of its security offerings. In these events, the company will issue an abbreviated prospectus. In fact, this filing represents all the company’s past public filing information. It allows investors to search the history of companies to get a better understanding of past filings, in preparation for new securities issued. 

Read the Investment Prospectus as Part of Due Diligence

Investors are wise to read the investment prospectus of any new company or fund they’re considering investing in. It’s available specifically for the purpose of helping investors make better decisions about where to put their money. It’ll have all the fundamental information necessary to give investors a top-down look at the investment vehicle they’re interested in.

And this is so important when determining how to balance and enhance your portfolio. To learn more, sign up for the Profit Trends e-letter below. You can learn more about investing and find expert stock analysis via this daily newsletter!

Best of all, prospectuses follow SEC filing rules. This means they’re relatively uniform in presentation. Once you have read one, you can easily pick up another to glean information about a company or fund worth investing in.


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