posted on 06-06-2019
Updated January 22, 2020

What Is a Prospectus?

A prospectus is a legal document that is required by the Securities Exchange Commission (SEC) to accompany securities or investment offerings for sale. A prospectus contains key facts and information about the offering to help investors make an informed decision. 

Companies must issue a prospectus prior to offering stock or bonds for sale to the public. In the US, all public companies that intend to issue securities to the public must also file a prospectus with the SEC. 

Mutual funds also provide a prospectus to potential clients, which includes a description of the fund's strategies, the manager's background, the fund's fee structure, and a fund's financial statements.

The purpose of the prospectus is to make investors aware of the risks of an investment. Without this information, they would essentially have to evaluate investment offerings without complete information. This disclosure also protects the company from claims that it did not fully disclose enough information about itself or the securities in question.

Types of Prospectuses

There are several different types of a prospectus that may be created for any number of offered products. Generally, they fall into one of these four categories:

  • Preliminary. A prospectus for stocks and bonds is issued in different stages. The first stage is the preliminary prospectus, which contains the details of the business and proposed financial action.
  • Abridged. An abridged prospectus is basically the summary of a prospectus. It contains all the important features of a prospectus in a condensed, reader-friendly version.
  • Shelf. This refers to the ‘shelf-life’ of the information as its only relevant for one year or less. Generally, only finance-based companies are eligible for creating a shelf prospectus.
  • Deemed. When a company agrees to give shares to an issuing house and then later sell to the public, the document disclosing the offer is deemed to be a prospectus. 

Why Is a Prospectus in Company Law Important?

To help illustrate the role of the prospectus for a company, let's say that Company XYZ is pursuing an IPO. Before launching the IPO, Company XYZ must first file a registration statement with the SEC, which discloses all material information about the company. Part of the registration statement is the prospectus and must be provided to all purchasers of the new issue. 

After Company XYZ files the registration statement with the SEC for review, a cooling-off period begins. During this 20-day cooling-off period, securities brokers can discuss the new IPO with clients, but the only information that can be distributed to them the preliminary prospectus.

When the registration statement becomes effective, Company XYZ will amend the preliminary prospectus to add important information like the offering price and the underwriting spread.

A final prospectus must contain the following:

  • Description of the offering
  • History of the business
  • Description of management
  • Price
  • Date
  • Selling discounts
  • Use of proceeds
  • Description of the underwriting
  • Financial information
  • Risks to buyers
  • Legal opinion regarding the formation of the company
  • SEC disclaimer

When the final prospectus is released, brokers can then take orders from those clients who indicated interest during the 20-day cooling-off period. A copy of the final prospectus must precede or accompany all sales confirmations.

How Are Prospectus and Registration Statements Related?

Registration statements have two principal parts. The first part is the prospectus and the second part is the additional information showing that the company does not have to deliver to investors but must file with the SEC.

The registration statement is only approved if the federal agency is satisfied that the security issuer has complied with all the rules governing disclosure.