What Is a Prospectus? Example, Uses, and How to Read It

What Is a Prospectus?

A prospectus is a written document used in finance to inform the public of the relevant details about an offering of securities, such as stocks, bonds, and mutual funds. The prospectus is part of a company’s registration statement, which must be filed with the Securities and Exchange Commission (SEC).

Key details on a prospectus include the number of units, the offering price, and how the company intends to use the capital it raises from the sale. Companies update their prospectuses each year. Investors can obtain prospectus reports by visiting the SEC EDGAR database. However, investors will also find that the best online brokerage and trading platforms provide access to prospectus reports, which may be easier to read.

Components of a Prospectus

The prospectus is a required disclosure document. As such, it must include all material information about the company, the offering, and any other relevant details.

• Company information: The prospectus should outline information about the company, how it operates, and its products and services.
• Management team: This section includes the names of the company’s key officers, their bios, and any other relevant information, such as pay/compensation.
• Financial statements: The company highlights its financial history and includes financial statements like its balance sheet, income statement, and statement of cash flows.
• Details of the offering: The prospectus should detail the type of security, the offering price, and the number of units the company wants to sell. If the company intends to sell stock shares, it should also detail the structure along with the number of authorized and outstanding shares.
• How capital will be used: The company explains how it intends to use the capital raised from investors.
• Investment objectives and results: Management outlines the investment’s objectives (especially in the case of a mutual fund) and provides its financial performance over time.

Other key information detailed in the prospectus includes the company’s competition, any risks a potential investor may face if they invest in the company, market conditions that could impact the company, and how the company intends to grow in the future.

Uses of a Prospectus

A prospectus helps investors and companies for different reasons. Investors can use this document to gain insightful information about potential investments, while companies can use it to attract new investors.

For Investors

A prospectus is a valuable tool to help investors decide whether to invest in the company. The prospectus provides investors with important information about an upcoming offering and other key details about the company’s management team, risk factors, the financial history of the company and the investment. The prospectus also informs investors on how the company intends to use the money it raises from the sale of its securities.

For Companies

A company produces a prospectus for two reasons. The first is to attract new buyers and investors by providing background about the company, its history, and details about its management team. Companies can use the prospectus as a marketing or sales tool that gives investors insight into the offering of its new security, including where and how it will trade, how much the units cost, and how they can purchase them.

The second purpose of the prospectus from a corporate perspective is to remain compliant with financial regulators—notably the SEC. Companies preparing for an initial public offering (IPO) must complete and file a registration statement called SEC Form S-1—including a prospectus—with the SEC before they can issue the securities. Mutual funds update their prospectuses each year.

How to Read a Prospectus

For investors to get a lot out of a prospectus, there are some critical sections to review. You can gain a lot of information from the summary, which highlights the details about the offering, the reasons behind it, and an overview of the associated risks.

Other sections to focus on include:

• Risk factors: This section helps you understand what factors may hurt your investment. For instance, the prospectus may outline risks like exchange rates, economic factors, market risks, and failure risks if the company faces challenges.
• Financial statements: Documents like the company’s balance sheet, cash flow statement, and income statement can give you insight into the financial health and well-being of the company.
• Investment costs: Read about the fees and any other charges associated with the potential investment. These costs can eat away at your capital over time.
• Use of capital: This section outlines how the company will use the money it raises from the sale of its securities. This is key, as it can signal whether the company is financially healthy and if it plans on investing this capital in its growth.
• Investment objectives: This section is key because you can determine whether your goals align with those of the investment and the company.

Since a prospectus contains a lot of legalese or financial jargon, be sure to consult an investment advisor if you’re unfamiliar with investing terminology and need clarification.

Example of a Prospectus

See the prospectus summary filed by Zoom Video Communications (ZM) filed on March 22, 2019, (linked here). The company prepared the filing before selling its Class A common stock to the public.

In the summary, the company outlined its history and corporate profile, which includes the business model along with its products and services.

Zoom also highlighted the industry trends, competitive landscape, market, and growth strategy before diving into the risks (found on page 6 of the prospectus). These risks included its limited operating history, delays, failures in internet infrastructure, and the possibility of an unstable revenue stream.

The prospectus also includes the type of securities sold and how many shares would remain outstanding. Zoom also included financial statements.

The Bottom Line

A prospectus can help you make important decisions about how you invest your money, whether you want to buy stock in a company or shares of a mutual fund. This document contains valuable information about the company, its objectives, offerings, how it intends to use the money it raises from investors, and the risks associated with investing in it. You can get a prospectus from the company, your broker, or the SEC.