A prospectus is a legal disclosure document that provides information about an investment offering to the public, and that is required to be filed with the Securities and Exchange Commission (SEC) or local regulator. The prospectus contains information about the company, its management team, recent financial performance, and other related information that investors would like to know.
Investors use the legal document to determine the growth and profitability prospects of the selling company to decide whether they will take part in the offering or not. In the U.S., the legal name of the public filing is an S-1.
Prospectus for a stock or bond issue
When a company is issuing stocks or bonds, it publishes a prospectus to provide investors with all the information that they need to make an informed decision. The issuer provides both a preliminary and a final prospectus. A preliminary prospectus is the initial offering document that provides details about the proposed transaction. The final prospectus is offered when the offering’s been finalized and is being offered to the public for subscription.
Information in the final prospectus includes the number of shares issued, offering price, company’s financial data, risk factors, use of the proceeds, the dividend policy, and other relevant information. This information helps an investor make an informed decision on whether to invest in the company.
Prospectus for mutual funds
A mutual fund prospectus is a legal disclosure document that the SEC requires mutual funds to file and make available to interested investors. The details provided in the document include the fund’s objectives, risks, performance, distribution policy, executive team, investment strategies, etc.
A mutual fund may provide a summary prospectus, which is a few pages long and contains important information that investors require. It may also issue a statutory prospectus, which is long and extremely detailed, to provide investors with as much information as they may need to make a buying decision. Mutual funds are required to give investors the document after the purchase of shares. Investors can also access the information on the fund’s website.
The prospectus gives an overview of the company since its creation. It provides a chronology of events that have occurred over the years, such as those that have helped the company experience growth. It also includes information about the founders, company registration, and initial service offerings. This section may also include an overview of the company’s strategy and what management believes is its competitive advantage or “unique selling proposition” (USP).
#2 Services/products offered by the company
The services/products section lists the core economic activities undertaken by the company. The company provides information about the services and products provided to customers, and any additions to its operations over the years.
#3 Management profile
A prospectus also includes information about the company’s executive management. It outlines the management team’s experience and education qualifications that make them a good fit for the company. Investors want assurance that the company’s executives have what it takes to safeguard their investments.
#4 Desired deal structure
If the issuer is an existing company that has issued securities before, it may provide an overview of its current capital structure and how the new issue will affect the structure. For example, when selling bonds, the investors will be interested in knowing the level of the company’s debt and its ability to pay. Equity investors will want to see the current equity ownership structure and how their investment will influence the structure and the expected rate of return.
#5 Use of proceeds
A company will often offer an issue of securities when it is unable to raise capital internally to finance a large investment. For example, the company may want to expand its operations to other geographical locations, acquire proprietary technology, purchase large machinery, finance the production of a new line of products, execute mergers and acquisitions (M&A), etc.
#6 Security offering details
The prospectus also provides information on the number of securities that are being offered to the public and the price for each security. It should also state the expected rate of return on the investor’s funds. This section also provides information on the subscription period when interested investors can purchase the securities.
#7 Financial information
The prospectus should provide investors with information about the company’s past financial performance. The information may include EBIT, net profit, stock performance, etc. The security performance can be compared to a known benchmark such as the S&P 500 or Dow Jones Industrial Average.
#8 Risks involved
The prospectus should disclose the risks that investors face when investing in a mutual fund. For example, an international mutual fund may include a disclosure detailing the currency risks that investors face when investing in the fund.
Other risks that a company may reveal include possible capital restrictions, government regulations, individual investors holding large numbers of stocks, etc. The disclosures protect the company from accusations that it withheld vital information that caused the investors to incur losses.
Prospectus in the United States
When a company intends to issue securities to the public, it must file the prospectus with the SEC. The security issue must wait for the SEC to declare the registration statement effective before they can finalize the sale. The registration statement is only approved if the federal agency is satisfied that the security issuer has complied with all the rules governing disclosure.
However, there are certain exemptions when filing a prospectus with the SEC. If a security issue is from a company that has been consistent with their 10-K Form filling and reports a market capitalization above the required threshold, the company may issue a simplified version that incorporates the information into their 10K filings.
Prospectus in the United Kingdom
In the United Kingdom, a prospectus is required for a security that will be offered to the public or that wants to register on a regulated market such as the London Stock Exchange (LSE). The security issues are governed by the Prospectus Rules, an extension of the Prospectus Directive in European Law, and must be approved by the FCA – Financial Conduct Authority.
Thank you for reading CFI’s guide to Prospectus. To expand your learning and advance your career, the following CFI resources will be helpful:
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