Prospectus in Investment Banking - Part 2

In the previous article, we explained what a prospectus is from an investment banking point of view. We also explained the legal importance of the document. Lastly, we also explained the various types of information that form a part of the prospectus. In this article, we will continue to look at some more types of information which are commonly included in the prospectus.

Financial Statements

During an IPO process, shares are often sold to institutional investors. These institutional investors have entire teams of financial analysts, which are very good at number crunching. They carefully study past financial statements to check whether they are genuine of whether any shenanigans have been used to make the company appear to be in better shape than it really is. Only once the validity of the past financial statements is verified does the team start having a closer look at future projections. It is for this reason that the past financial statements of a company might often be mentioned in great detail within the prospectus.

Management Team

Investors who have experience with IPO investing believe that people are the most important asset of any company. Many investors do not look at the financials as closely as they look at the people involved with the company. The decisions made by the top management of the company literally make the difference between the success and failure of that company. This is the reason that there is a separate section in the prospectus where the details of important executives like a chief executive officer, chief financial officer, chief operating officer, etc. are mentioned in detail. Details of the board of directors are also mentioned in the prospectus, along with their short biography. The reason behind this is that it is the board of directors who are supposed to manage the top officers of the company.

Executive Pay

Many investors are interested in knowing the details of the compensation which is offered to the top officers of the company. They are also interested in knowing the manner in which these executives are being paid. This is because chief executives do not receive just a base salary. They are compensated with stocks, warrants, and several other forms of compensation. In many countries, the law mandates that this information be neatly arranged in a tabular format and presented to the investors. Many investors just want to know if the chief executives of the company have any "skin in the game."

Related Party Transactions

Many of the companies which go public were earlier family-owned businesses. Hence, they often tend to have a complicated relationship with many other group entities, which might still be family-owned. In the past, there have been cases where promoters of the companies going public have indulged in unethical behavior. As a result, they were able to siphon off wealth at the expense of the poor shareholder. In a lot of cases, this siphoning off is enabled by related parties. This is because while dealing with related parties, promoters can be on both sides of the transaction. They can deliberately make deals that will benefit them at the expense of other shareholders. As a result, regulatory bodies all over the world have made it mandatory to disclose related party information so that dealings with related parties can be scrutinized.

Legal Issues

It is common for companies engaging in business to be the target of many lawsuits. However, some lawsuits can end up becoming the root cause of a huge liability in the future. Hence, any company soliciting funds from investors is legally bound to disclose all information about existing as well as potential lawsuits.

There is a separate section designed in the prospectus where the company is supposed to give the detail of each and every litigation, no matter how minor it is. The company is allowed to give commentary explaining the context of the litigation. However, the information is disclosed to prospective buyers so that they can make informed decisions.

As already mentioned above, a lot of these lawsuits are frivolous and have very little impact on the valuation of the firm. However, a handful of them can seriously dent the value proposition of any business.

Selling Shareholders

When an IPO is launched, existing shareholders are generally selling their shares. This is the reason why these shares are available for the general public. It is possible that new shares are being issued, but that is unlikely. In most cases, some of the old shareholders are selling. There is a section in the prospectus where details about who is liquidating the shares are mentioned. If companies like venture capitalists and other investors are liquidating their stake, then it is not considered to be a negative sign. However, if the promoters, executives, or other people with privileged information are the ones selling the shares, then it is considered to be a negative sign.

Capitalization Policies

The prospectus also mentions details of the various types of debt that the company has already taken or is planning to take in the near future. The company generally outlines its views about debt as well as the target debt-equity ratio that they are looking to maintain. This helps investors decide whether or not the philosophy of the company is aligned with their personal risk appetite. Details about debt and preferred stock are also considered important since they also explain how likely the shareholders are to be paid in the event of a default.

It is important to understand that the above-mentioned list is only indicative and not exhaustive.

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Investment Banking