August 11th, 2008 | 
Author: A prospectus is a legal document that makes investors aware of the risks associated with the investment. It is issued when a company wishes to tap the capital markets through an Initial Public Offer (IPO). Mutual funds too issue a prospectus when they aspire to raise funds for a mutual fund investment scheme.
The prospectus contains vital facts of the company that are extremely important to aid the potential investor to make an informed decision. These facts include nature of business, financial history, background of Board of directors, reasons for which the issue is being made. In the case of mutual funds these facts include the fund?s objectives, history, investment manager?s background, and financial statements.
Before a final prospectus is issued, a red herring prospectus is issued. A red herring prospectus is a preliminary registration statement filed with the Securities and Exchange Commission (SEC) describing therein the new issue of shares and the future prospects of the company. It does not contain the price at which the stock will be issued nor does it contain the issue size. It is updated several times before being called a final prospectus. It is known as red herring because it contains a passage in red the company will not attempt to sell the shares until the issue is approved by the SEC. The final prospectus is the document that is issued to potential investors. The difference in the two kinds of prospectuses confines to the fact that the final prospectus contains the issue price and the issue size which you will not find in the red herring prospectus. The final prospectus must be given to every investor who invests in newly registered securities.
It is vitally important to read the prospectus before making an investment decision. The trick is to identify and understand those statements that tell you about the company and its future prospects rather than those general statements that you will find in all prospectuses.
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