Knowing what you are reading when you read a prospectus

Demand for new issues has been thin during the past few years, however there are many companies waiting to introduce their stock to the public once the markets do turn.

When the faucet is turned on, investors will be facing a number of investment choices – not all of which may merit their attention. If consideration is being given to purchasing stock in an initial public offering or secondary offering, the prospectus is one of the most important documents for investors.

But what should you look for when reading a prospectus? Here are a few hints:

Company’s Business Model – A potential investor should be comfortable with the issuer’s business model including the company’s actual products or services provided, strengths and weaknesses within its industry, the diversity of the company’s customer base, the competitive landscape and strategies for future growth.

Offering Composition – Determine if the offering is 100% primary stock (coming from the issuing company) or if there are any selling shareholders. If there is a selling shareholder component, analyze the shareholders’ stock positions before and after the offering and determine the reason for the shareholders’ desire to liquidate.

Financial Statements & Management’s Discussion – Develop a general understanding of the trends in the company’s top and bottom line. Review the company’s capital structure and accounting methods. Also check for any pending legal matters.

Risk Factors – Potential investors should review this section of the prospectus very closely. Understand each point in-depth and determine whether the risk of the offering is tolerable considering your own risk tolerance profile.

Use of Proceeds – Determine the use of the proceeds from the offering. There should be a defined use of proceeds that will improve the issuing company’s fundamental story in some way, whether it is through funding an acquisition or future growth, improving the capital structure or another reason.

Management – Educate yourself on the issuer’s management team. Focus on their experience within the industry, their compensation structure, the level of insider ownership and other incentives they have.

Board of Directors – Also research the company’s board of directors for level of experience and how they are compensated. Determine the number of outsiders on the board.

Underwriters and Accountants/Auditors – Determine the experience and reputation of both the underwriters of the offering and the company’s accountants/auditors.

Before investing in a public offering, or any offering for that matter, read the prospectus carefully and don’t be afraid to ask your financial advisor questions.