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Maryland Securities Division - Investor Education
to Read 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 Commission (SEC).
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.
Parts of a Prospectus and Factors to Consider
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 information.
Read the summary to determine if this is the type of company you are interested in, and if its goals seem to be achievable.
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).
Examine the 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.
If receiving income is important to you, you may not want to invest in a company that does not pay dividends.
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 Financial Statements.
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 Operations
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 financial condition.
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.
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.
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.
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.
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 Notes
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.
Although these 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.
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Attorney General of Maryland 1 (888) 743-0023 toll-free / TDD: (410) 576-6372