An IPO prospectus is a legal document that accompanies a security offering such as a stock or a mutual fund. If you are researching an IPO, the prospectus may be the best (and only) source of information about a company. But reading one can be a challenge because it must conform to the SEC requirements to disclose all material facts and can be up to 200 pages, most of it legalese. But you can extract all the pertinent information in five minutes or less by using a few simple shortcuts.
You can access the prospectus free online on the SEC website. As long as a prospectus provides full disclosure, its format may vary but all of them contain a few essential parts.
Prospectus Summary
Read the business description to get an idea about the company and its competitive strengths. You don't need to dig too deep because these descriptions are written by professional story tellers who can make you salivate even when selling a pile of junk. All you need to know is what the company does and whether they have an edge. In other words, they are selling, why should you be buying?
The Offering
The offering contains the basic information: how many shares will be sold, how many shares will be outstanding after the offering, who is selling them, the use of proceeds, the lock-up period and the symbol.
Generally, the fewer shares sold to the public, the greater the potential investor demand for them can be. Very large offerings rarely present good investment opportunities. Comparing the number of shares being offered to the number of shares outstanding can give you an idea of how many more shares can be sold after the lock-up expires. The lock-up period (usually 180 days) bans insiders from selling their shares for a period of 6 months. After the lockup expires, insider shares may flood the market and put downward pressure on the stock price.
It is important to see how the company is planning to use the proceeds from the offering. The purpose of an IPO is to raise money for expansion so "for general business purposes" is good enough. A small number of shares can be sold by the selling shareholders, with the proceeds going to them, not the company. That's normal. But sometimes most, or even all, proceeds can go to the selling shareholders. It's a red flag. If the current shareholders are selling, why should you be buying? To make them rich?
Summary Consolidated Financial Data
This headline may also contain the words "unaudited" or "selected" but the bottom line is that you want to see a financial table that shows revenues and earnings for the past quarter or six months. You want to see if the company is making or losing money, and whether it's growing. Sales and earnings growth is the best validation of the glorious story in the Summary.
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