What is a prospectus? 

prospectus

A prospectus is a legal document by which a public company raises money from investors.

How a company raises money from the public?

All companies or organizations provide a prospectus to its clients, which includes all the information like company promoters, fund’s strategy, managers background, financial statements, previous achievements, etc.

It is a notice, document, circular, advertisement by which a company appeals for an investment. Only public companies use a prospectus in order to show the details of the company to its investors.

Companies use various types of prospectus. All have a different usage, which is discussed later in this article.

A prospectus is given to the public prior to an IPO. It is issued to the public so that investors can decide whether to invest in that company or not by looking at its fundamentals.

Types of prospectus 

Red Herring Prospectus

A prospectus for stocks and bonds are issued in different stages – the first stage is the preliminary prospectus, which contains the details of the business and proposed financial action. It is nicknamed as Red Herring.

The word Red Herring means to distract or mislead someone from an important issue. When a company decides to attract investors to invest in their company, they use a prospectus named Red Herring Prospectus.

Details available on Red Herring prospectus are :

red herring prospectus

It is basically a prospectus which is used in the public issue to attract different investors. In this prospectus, the price and quantum are not mentioned or disclosed.

Here price means the actual price to be issued per share in the IPO and quantum means the quantity or the total number of shares to be offered in the IPO.

Abridged Prospectus

Abridged Prospectus is the actual summary of a prospectus. It contains all the salient features of a prospectus. The original prospectus that a company files to the exchange regulator is too large. The abridged prospectus contains the summary of the same prospectus.

Reading the entire prospectus may be too much time consuming for an investor. Instead, they go through the abridged prospectus, which gives them the basic idea about the company.

The abridged prospectus contains all the important and materialistic information. No company will issue the share buying from without the abridged prospectus attached to it so that investors can take a well-informed decision.

Shelf Prospectus 

Shelf means ‘life’ or ‘validity’ of a prospectus. Only selected companies bring their shelf prospectus. All companies are not eligible for designing a shelf prospectus. Normally finance-based companies are eligible for bringing out their shelf prospectus.

Shelf prospectus has validity with a maximum of one year. There are various companies which frequently raise funds (ex. banks) for issuing loans.

Every time they raise funds from the public, they require approval from the Stock Exchange and Registrar of Companies(ROC).

Also, every time a company wishes to raise funds again, they must file their prospectus to the regulators for approval. If any company submits their Shelf prospectus, they don’t have to file the prospectus again and again while raising funds for that particular year.

A company filing a Shelf prospectus have to file an Information memorandum which must contain:

  • Any changes made by the company after the previous offer security.
  • Any new charges created if any
  • Any new material or facts created

After the validity period is over, the company has to submit another prospectus which will be valid for another one year.

Deemed Prospectus 

Deemed means to presume something. When a company agrees to allot shares to an issuing house( which is a different company) which they will later sell to the public, then the document by which offer is made is deemed to be a prospectus.  

The document by which the issuing house offers share to the public is said to be deemed prospectus.

Any one condition from the following two conditions should be fulfilled:   

  • The issuing house should issue the shares to the public 6 months after the agreement with the company whose shares are to be issued.
  • The issuing house shouldn’t give the share price to the company until they bring it to the public.

Conclusion

As we came to know that a prospectus is nothing but a legal document which provides details about investment offering sale to the public.

The prospectus informs investors of the company’s history, management biographies, financial statements, best and worst-case scenarios of the companies performance and any other information that will help investors make an informed decision about the investments.

Mutual Funds must also issue a prospectus, because a mutual fund continuously offers shares to the public. Now, let’s summarise what we have discussed in this article.

  • We have discussed the definition of prospectus.
  • Why do you need prospectus?
  • The different types of prospectus.
  • Companies that are eligible for shelf prospectus.
  • Conditions for a deemed prospectus.

Also Read: What is IPO? How a company raises funds in IPO

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