How a Prospectus Works: 8 Components of a Prospectus - 2021

A prospectus is a legal document released by a company to inform potential investors about the planned issuance of a new security, which can be shares of [stock](https://www.masterclass.com/articles/what-are-stocks), exchange-traded funds (ETFs), or mutual funds. A prospectus provides information that an investor will want to know about the company, its management team, financial performance, and growth potential in order to make an informed decision that aligns with their risk tolerance. The US Securities and Exchange Commission (SEC) requires US-based businesses to submit a prospectus as part of their registration statement—a detailed disclosure containing relevant information such as [business plans](https://www.masterclass.com/articles/what-is-a-business-plan-learn-how-to-write-a-business-plan-in-8-steps), management overview, and financial conditions. A company generally files two prospectuses for a new security: a preliminary prospectus, issued when the company plans to make the offering public and wants to gauge investors’ interest, and a final prospectus, issued when the offering is ready for the public. A company will task its legal and accounting department with preparing the preliminary prospectus, which offers basic information on the company’s business and the security itself. The company will then file it as part of its public filing, known legally as an S-1, to the SEC and then wait for the commission to approve the document. When they believe that the public has been sufficiently informed about the security by the preliminary prospectus, the company will then issue the final prospectus, which provides detailed investor information, like the price and the company’s plans for the funds raised by the security, before or at the point of sale. There are several different types of prospectuses, including: 1. __Abridged prospectus__: An abridged prospectus is a reader-friendly distillation of the important information in a prospectus. It’s also known as a summary prospectus. 2. __Deemed prospectus__: A company may choose not to sell securities directly to the public but instead employ an issuing house, which handles that task. The document released by the issuing house to the public is considered a deemed prospectus. 3. __Final prospectus__: The final prospectus provides a greater amount of information about the stock or bond, including the offering price, number of securities to be made to the public, the company’s major competitors, financial growth, dividend policy, which is how investors receive compensation, and the information in the preliminary prospectus. 4. __Mutual fund prospectus__: A mutual fund prospectus, which is also known as an ETF prospectus, includes information on the fund’s objectives, investment strategies, the mutual fund’s past performance, any potential risks, the distribution policy, and information on the management team. It may also include a summary or statutory prospectus. 5. __Preliminary prospectus__: A preliminary prospectus is also known as a “red herring” prospectus because it’s used to attract prospective investors. It’s the first prospectus issued by a company for its [initial public offering](https://www.masterclass.com/articles/initial-public-offering-guide) (IPO) and contains only basic details about its business and the nature of the security. 6. __Shelf prospectus__: Finance companies issue shelf prospectuses for multiple security offerings issued all at once, which is known as “shelf registration,” so they don’t have to release a prospectus for each security. The shelf prospectus contains information that is typically valid for a limited time, or its “shelf life,” usually a year. 7. __Statutory prospectus__: A statutory prospectus is essentially a summary prospectus but provides greater detail and is often used with mutual funds or ETFs. A prospectus has many components, each providing specific information to an investor: 1. __Company overview and history__: This overview contains the company’s chronological history and its accomplishments during that period that have helped it grow, including [business strategies](https://www.masterclass.com/articles/bob-igers-5-tips-for-developing-a-business-strategy), financial statements, and what distinguishes the company from its competitors, also known as its “[unique selling proposition](https://www.masterclass.com/articles/how-to-create-a-unique-selling-proposition-for-your-business).” 2. __Deal structure__: This component is usually provided in prospectuses from companies that have issued securities before. It explains its capital structure: how much debt or equity it owns, how the investor’s participation will influence that structure, and how it would like its capital structure to look in the future. 3. __Financial information__: The company may also provide detailed information on its past financial performance over a specific period, including stock performance, gross and net profit. 4. __Management profile__: A management profile is a detailed list of the company’s executive management, including their education and qualifications. It may also explain how their company will protect investments. 5. __Risk potential__: Providing risk potential to investors informs them about any potential concerns they might face when investing with a company, including government regulations and capital restrictions. Adding this component to a prospectus can also protect companies and their brokerage firms from accusations that they withheld information about the security that could cause investors to lose money. 6. __Securities offering__: The security offering refers to a round of fundraising in which the company tries to bring in extra capital from investors to fund their expansion. The company can offer investors one of two types of securities in exchange for funding: debt securities (a bond that the company must repay at a specific date of maturity) or equity securities (stocks or partial ownership in the company). The data from this fundraising round and the expected rates of return are typically included in the prospectus. 7. __Services and products__: This component is an additional element of the company overview and may include what it makes or sells to the public. It may also include any additions it’s made to its operations during its chronological history. 8. __Use of proceeds__: In the use of proceeds, the company explains what it plans to do with the investments, which can include financing for new products, company expansion into new territories and areas, and the purchase of new technology. Get the [MasterClass Annual Membership](https://www.masterclass.com) for exclusive access to video lessons taught by business luminaries, including Howard Schultz, Chris Voss, Robin Roberts, Sara Blakely, Daniel Pink, Bob Iger, Anna Wintour, and more. A prospectus provides investors with all the information they need to back your company when it goes public. In order to craft a perfect prospectus, you first need to understand all the required elements.