A Beginner's Guide to
Reading and Understanding a Company's Prospectus
A prospectus is a
document that should disclose all the important facts about a company that is
selling securities. It can be an important sales tool for both the company and
the brokerage firms that market the securities for the company.
A prospectus is
also a legal document. If the stock does not do as well as you expect and you
end up in a dispute, the company and the brokerage firms may use the prospectus
as evidence that you were given all of the important facts about the company and
its securities offering.
State and federal
law require that you be given a prospectus before you buy securities in a public
offering. If you buy securities after the public offering, you may find the kind
of information generally found in a prospectus in the annual report, and in
reports that companies are required to file with the Securities and Exchange
In an effort to
make the prospectus easier to understand, the SEC has recently passed a rule
requiring that the cover page, summary and risk factors sections of the
prospectus be written in "plain English." This means that companies should use
active voice, short sentences, and no legal jargon or highly technical business
terms in these sections. However, a prospectus is often prepared by lawyers.
Other sections may contain legal jargon. You should make sure that you
understand the information in the prospectus. Make sure that any explanations
you receive are consistent with the information contained in the prospectus.
You should take
whatever time is necessary to understand the information. First, become familiar
with the basic parts of the prospectus. Then, consider the information in each
part so you can make an informed investment decision.
PageThe Cover Page identifies the company offering the
securities, the cost per share, the total amount of money to be raised by the
company from the sale of the securities, and the name of the brokerage firms
selling the securities. The front page will indicate if it is a preliminary
prospectus. A preliminary prospectus is in the process of being reviewed by the
SEC and the states where the offering is being registered. Information may be
added or changed at a later date. Typically, a preliminary prospectus does not
include the purchase price or the number of shares that will be offered for
As indicated on the
cover page, neither the SEC nor the Maryland Securities Division will recommend
or offer an opinion concerning the securities offered by the prospectus.
Regulators review the prospectus to ensure that it contains the type of
information that you need so that you have an understanding of the offering and
the risks involved. Neither agency can attest to the accuracy of that
SummaryThe Prospectus Summary briefly describes the company and
its location, the kind of product it sells or the service it provides, its goals
for the future, and its plans for achieving those goals.
Read the summary to
determine if this is the type of company you are interested in, and if its goals
seem to be achievable.
FactorsThe Risk Factors section lists and briefly explains the
risks relating to the operation of the company, sale of its products or services
in the marketplace, and other factors that may affect the ability of the company
to succeed. Often, a risk factor will refer you to another part of the
prospectus that contains a more detailed discussion of that particular risk.
As you read through
the rest of the prospectus, consider whether these risk factors are acceptable
to you. Risks may be common to the industry (e.g., the price or availability of
a raw material, a highly competitive market), or unique to the company (e.g., a
very high debt ratio, dependence on key personnel). Look for risks that may
affect the company after you have invested in it (e.g., the risk that the
company's product may become obsolete).
ProceedsThe Use of Proceeds section explains how the company
plans to spend the money raised in the offering.
intended use of funds received from the offering. If a substantial percentage of
the proceeds is to be used for "working capital," management has broad
discretion to use these funds, including using money for purposes not discussed
in the prospectus.
PolicyThe Dividend Policy section explains whether the company
plans to pay a portion of its profits to investors, or whether all of the
profits will be kept by the company to finance its growth.
If receiving income
is important to you, you may not want to invest in a company that does not pay
Capitalization section identifies the amount of money owed to
creditors, received from shareholders, and generated from operations, both
before and after the offering.
Check to see
whether the company's cash flow appears to be adequate to pay its debts. To
obtain details of the company's long-term debt, refer to the Notes to the
Dilution section compares the book value per share (i.e., assets minus
liabilities divided by number of shares of common stock outstanding) with the
price you are paying per share.
If the book value
per share is substantially less than the price you are paying per share, you may
be paying too much for your shares.
Discussion and Analysis of Financial Condition and Results of
OperationsThe Management's Discussion and Analysis of Financial
Condition and Results of Operations section provides management's
explanation of how the company has performed in each of its most recent quarters
This section gives
you an idea of positive and negative trends in earnings and expenses. Read it
carefully to see if you agree with management's estimations of the company's
Business section presents a detailed description of the company's
history, business plan, method of operation, and competition.
Look at the age and
track record of the company, as well as the market for the company's products or
services. Consider whether the market for the company's products or services
seems to be growing. Note if the company is dependent on a few key clients or
key suppliers. Understand who or what constitutes competition for the company.
Management section identifies the officers and directors who run the
company, describing their education and work experience. It also identifies the
officers who receive more than $100,000 a year in compensation.
Consider how much
experience in a similar type of business the management brings to the company,
and how much time each member of management will devote to the company. Also,
check to see if management consists of one or two key individuals and how
dependent the company seems to be on these individuals (this may also be
discussed in the Risk Factors section). In the subsection on compensation, note
any special option plans, stock appreciation rights or other "unusual"
compensation arrangements. For example, consider whether you want to invest in a
company whose management is only part-time and receiving huge salaries and
benefits or stock options.
TransactionsThe Certain Transactions section identifies
transactions between the company, its officers and directors, and other parties
related to the company or to management. This discussion highlights possible
areas that could lead to conflicts of interest, or special, favorable treatment
being given to insiders or other related parties.
Look for loans to
officers and directors, or for leases of equipment or space from members of
management. Some of these transactions may not be competitive, or in the best
interest of the company.
ShareholdersThe Principal Shareholders section discloses how
much of the company is owned by management, and identifies executive officers,
directors, and individuals who own more than 5% of the company.
If you look at the
table of shareholders, you can tell whose ownership is changing because of the
offering. If a number of the original investors are selling out, they may know
something about the company that you do not.
Underwriting section lists the brokerage firms responsible for the sale
of the securities, and describes how they are compensated for selling the
Check to see if the
offering is "firmly underwritten" or offered on a "best efforts" basis. In a
"best efforts" underwriting, the brokerage firm does not guarantee that all of
the shares offered will be sold, and only promises to use its "best efforts" to
make the offering a success. Firm underwriting means that the brokerage firm has
committed to buy all of the securities offered. Thus, in a firm underwriting,
the company is virtually assured that it will receive all of the money it hopes
to raise in the offering.
Statements and NotesThe Financial Statements and Notes section
describes the financial condition and performance of the company, including
whether the company made a profit or sustained a loss during its most recent
year of operation.
Check the auditor's
letter to see if the auditor expresses a concern about the ability of the
company to remain in business. Take the time to read through the notes, which
will provide insights into the business operations of the company.
considerations will help you make an informed investment decision, they are not
comprehensive. You need to do your own homework, and use your own judgment.
Before making any
investment, be certain that you know what you are investing in and what risks
you are taking. Make sure that you are given a copy of the prospectus, and read
it before you invest. If you don't understand a part of the prospectus, don't
hesitate to ask your stockbroker or other financial professional for assistance.
Make sure that you
contact our office to check the registration status of the investment that you
are being offered. While the Maryland Securities Division cannot advise you on
the merits of a particular investment, we can tell you whether or not that
investment is registered or needs to be registered with our office.
You may also
contact our office for information about the brokerage firm or stockbroker who
sells you securities. The Securities Division can tell you whether or not the
brokerage firm or stockbroker is or needs to be registered in Maryland, or is
the subject of any complaints.
Call us, we're here
to help!The Maryland Securities Division(410) 576-6360
200 St. Paul Place, Baltimore, MD 21202
410-576-6300 / En español 410-230-1712 / 1-888-743-0023 toll-free / TDD: 410-576-6372