How to Read an IPO Prospectus
An Initial Public Offering or IPO is a process where companies transition from being a private entity to public through the sale of a company’s stocks to public investors.
When a company initiates an IPO, an official legal document is required to be filed with a Securities Exchange such as SGX where details of the investment offer will be made to the public. An IPO prospectus may look intimidating as it has typically a few hundred pages of legal description and financial jargons. However, one need not read the entire document from the first all the way to the last page. Below shows a quick and simple breakdown of what retail investors can look out for in an IPO prospectus.
1. Understanding the Company’s Business and its Industry Position
The IPO prospectus would have an overview of the company’s business model and an industry outlook. Time should be taken to read these portions and understand the company’s operations and how it could fare in its industry going forward. At times, it might contain useful statistics (some of which can only be attained through third-party paid research companies) pertaining to the overall industry which might aid in an investor’s investment decision process.
2. Use of Proceeds
The section explains why and how the company is going to utilize public investors’ equity capital to grow their business. IPO proceeds should usually be used either to fund expansion through buying new PPE (property, plant and equipments) and/or working capital; buying another company or be used to pay down debt. If the family or founders are selling a large amount IPO, becareful as it might signal that the company might take the IPO opportunity as an exit strategy (a common strategy for companies nonetheless).
3. Risk Factors
This section points out to investors certain external events which might adversely impact the company’s business operations and financial performance. Some of these risks (e.g. operational, legal and/or political risks) might include the dependence/loss on a single major customer or suppliers; reliance on a certain product.
4. Proposed Offering Size
This describes the amount of monies the company intends to raise. It is usually located in a colored box in the beginning of the prospectus. Usually, the number of shares to be offered and the price per share will be indicated.
5. Related-Party Transactions (or Interested Person Transactions)
Examine any sizeable transactions and relationships (although not illegal) for any unethical behavior. Several transactions might be fishy which could indicate the company is being run like a personal bank for insiders. Frequent company loans to insiders on generous lending terms might also indicate a red flag.
Pretty straightforward. It is always good to know whether the captain knows how to steer a ship or sink one. Understanding who are the managers can offer key insights on the managers’ experiences, their background and whether they have ever been involved in a legal suitcase (a quick search on their names on Google would help).
Value In Action
An IPO Prospectus is a very useful set of documents to check on a company’s business operations when it decides to list itself. The prospectus should also be read in conjunction with annual reports as well for studying already listed companies to get a foothold of a company’s operating history.
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All views and opinions articulated in the article were expressed in Willie’s personal capacity and do not in any way represent those of his employer and other related entities. Willie does not own any shares in the companies mentioned above.
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