A prospectus definition of an investment can be compared to a course outline for a class. Before enrolling in either, knowing what we’re getting into is important. Likewise, reading the prospectus is essential to make an informed decision before purchasing a security. The process is different for stocks and mutual funds, and ETFs. This legal disclosure document can be found on the company’s website and EDGAR, thanks to the SEC. We’ll look at the differences and components and their importance for investors.
Before a stock goes public with an IPO, a prospectus is required to be filled with the SEC. Then, this document is made public.
A preliminary prospectus, also called a red herring, and a final prospectus must be filled.
In some cases, an abridged prospectus can also be filed. There is a different prospectus definition for each stage of the IPO process.
Preliminary vs Final Prospectus Definition
The preliminary prospectus definition includes the most important business and transaction details. It has to be as appealing as possible to investors to gain their interest in the stock.
It doesn’t contain any price information or number of shares outstanding. Some companies are well-known in investor circles and don’t need a lot of effort to grow interest. Other smaller, lesser-known companies need to put more effort into their prospectus.
The final prospectus contains much more information. We can also find the offering price and the number of outstanding shares. The following information is contained in a prospectus.
Components of a Stock Prospectus
Overview of the company: Details of the business, sectors concerned, previous and future growth opportunities, strategy, and unique selling proposition (USP).
Financial information: Assets, liabilities, revenues, existing financial statements, company structure, debt repayment, etc.
Company executives: CEO, CFO, top executives’ education, experience, and qualifications.
Share information: Amount and price of outstanding shares at offering, common and preferred shares. How will the proceeds of the IPO be used (mergers & acquisitions, research & development, etc.)?
Pubic or Private offering: Available to anyone or only accredited investors
Underwriting banks and financial institutions
A stock prospectus definition aims to inform investors about the company and be transparent. Furthermore, it outlines the risks investors take by investing in the company. For example, some companies are decades old and decide to go public to secure more financing to catch up to competing companies.
Other companies are less than a decade old and are riddled with debt but have huge growth opportunities. Such examples are Uber, Lyft, and many other startup tech companies. They are given unicorn valuations. There is a lot of risk and upside when investing with them.
Misleading Prospectus Information
When filing for a prospectus, a company is protecting itself. Any misleading or intentionally left-out information can lead to civil and criminal penalties and imprisonment.
In any case, investors are responsible for conducting their due diligence on the stock before purchasing it. But, again, knowing the prospectus definition can be helpful if and when you’re researching.
As a shareholder, you are also entitled to certain rights. For example, common shareholders are paid after creditors, bondholders, and preferred shareholders if the company goes bankrupt.
They also hold voting rights, ownership, the right to transfer ownership, dividends, inspecting corporate documents, and the right to sue for wrongful doings.
In some cases, shareholders of certain companies receive company-specific perks. For example, shareholders are entitled to discounts and certain perks when holding a minimum share.
Be sure to read all the information sent to you by the companies you own. You might be in for a pleasant surprise with what’s included in the prospectus definition.
EDGAR
Company prospectuses can be found through EDGAR (Electronic Data Gathering, Analysis, and Retrieval system). This link is not for mutual funds or ETFs.
It is a free online database system the SEC maintains for domestic and foreign companies trading on US stock markets. Every public piece of corporate information can be found on EDGAR.
There is a lot of information and documents, many useless to most shareholders. And can be helpful with a prospectus definition.
Prospectus for Mutual Funds and ETFs
Now let’s move on to mutual funds and ETFs and the prospectus definition. In this case, investors aren’t investing in a single company but in many stocks, bonds, and other financial instruments. A prospectus is also called a fund fact.
It is usually updated at least annually unless there is a significant material change. What information can we find there?
Components of a Fund Prospectus
Product summary: Many general questions are answered. What does the fund invest in? Which sectors are included? Is it passively or aggressively managed? What is the objective and strategy of this fund?
Fund facts: Which asset class and category does the fund belong to (tech, health, utilities, etc.), ticker symbol, tax information?
Fees: expense ratio and management fees (the amount paid back to fund managers). A quick side note for the expense and management fees. Many ETFs charge less than 0.5% unless they have a high portfolio turnaround. On the other hand, mutual funds can easily charge over 1.5-2%. This is because ETFs are cheaper and carry lower fees than mutual funds.
Price and performance: Cost of one unit, performance over one month, three months, six months, one year, three years, five years, and since inception. It also includes hypothetical growth from $10,000 from 10 years ago. It can be compared to a benchmark or another popular fund in the industry.
Risk potential: Usually on a scale from 1 to 5, 1 being lower risk & lower reward, 5 being higher risk & higher reward. This includes the stock market, sector, non-diversification, and investment style risk.
Portfolio composition: Which sectors are included in the fund, the top 10 holdings, investment in value or growth stocks, the total number of stocks, the total assets invested in the fund, domestic holdings, foreign holdings, and the repartition between cash, stocks, bonds, and other financial instruments.
Portfolio managers: Who is working on the portfolio?
EDGAR
How do we find a prospectus for funds? In the same way, we do for stocks, EDGAR has once again the solution. Follow this link only for mutual funds. Unfortunately, there isn’t an EDGAR link for ETFs.
However, ETF fund facts can be found on companies’ websites managing each fund. Popular examples are Vanguard, iShares, or index funds.
Just like for public companies, funds are vulnerable to lawsuits. They release as much information as required to the public to protect themselves and stakeholders from preventable negative consequences. Know the prospectus definition.
Conclusion
To conclude, it’s important to know what a prospectus definition is. A prospectus is a very useful document for investors of any level. Before the IPO is completed, it summarizes the company. For lesser-known companies, it is a useful tool to gain the attention of various investors. As for funds, they are required to update their prospectus at least annually.
However, if there is a significant material change, it should be done more frequently. In any case, it is a very useful document. In addition, the SEC’s EDGAR website contains its contents for stocks and mutual funds.
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