By now you may be thinking that this series of articles is longer than a typical prospectus. In our first two installments we began our look at prospectuses, and the signals they send (BUYER BE WARY – BETWEEN THE LINES, PART I and BETWEEN THE LINES, PART II).
In this installment we take a look at the Company, the people who run and control it, and money, money, money!
The Company (a/k/a The Business)
Obviously, this section will differ significantly from deal to deal. Every description of the company will, however, have certain common elements. Look at the Company’s history. Has it successfully developed its business before the public offering or is it a "start-up?" Does it face stiff competition, and are its competitors well known, more established and better financed? Once you have reviewed the business section, sit back and decide why you would rather invest in this Company than in one of its competitors. Does it have fresher ideas? Superstar managers who have demonstrated an ability to excel and innovate? If not, you may want to look at the competition instead.
This section will also tell you whether the Company has more than just a good idea. How many employees are there, and what functions do they perform? Does the Company rent its operating facilities, or does it own property? In short, is the Company in a position to fulfill its plans. If it doesn’t have the facilities, plants, offices or personnel, the business may be a lot farther from profitability than you have been led to believe.
Which leads us to another concern. Is the broker suggesting that there is information about the Company that is not included in the prospectus? Or that is inconsistent with the prospectus? If a broker ever suggests this, or tells you to just ignore the prospectus, hang up the phone, forget about the investment and call the regulators. When you hear that kind of sales pitch you can be sure that somethin’s rotten on Wall Street.
Management
A good idea can be a potential goldmine. Just look at the slew of hi-tech companies that trade at multiples that can double for zipcodes. But even the best laid plans can go awry without sound management. The management section will tell you who is running the Company. How experienced are the people calling the shots? Do they have a background in the industry? Have they been successful? And are they replaceable? Is the Company built around one "superstar?" If it is, the Company, and with it your investment, could be one banana peel away from oblivion.
If the people in charge seem capable, are they locked into long term contracts? How much do they get paid? Can they be fired if they don’t perform? If so, what will it cost the Company? Some employment agreements provide generous compensation packages for severed employees and can pose a financial burden for the Company.
Do the Company’s executives own stock and do they have stock options? In short, do they have a financial interest in the company’s success? Options can keep good personnel at the Company, particularly if they are contingent on continued employment. Consider also whether the options are tied to the Company’s success. If they are, they provide an additional incentive for management to perform well.
And remember. Running a public company is far different from operating a private enterprise. Has management had experience in the public sector? Or will they be learning on the job, and on your investment?
Then look at the directors. What are their backgrounds? There is some comfort in knowing that some of the company’s directors have served on Boards of Directors before, have a background in, and understanding of, the Company’s business, or work in related areas that supplement or support the company’s operations. It is also important for a Company to have a sufficient number of "independent" directors who are not involved in the Company’s day-to-day management. Independent directors can be more objective when it comes to making hard decisions about the Company’s future.
Principal Stockholders
The Company’s principal stockholders may include its founders, promoters, senior management, lenders and venture capitalists who provided the company with its earlier funding. As a potential investor you want to know how each of these individuals (and entities) received their shares. What did they pay, and how long have they held their stock positions?
The stockholdings of every officer, director and 10% stockholder must be included in the prospectus. Once you see who holds the largest number of shares you will be able to develop a pretty good idea of who controls the company. Does management own a majority of the shares, or are they in the hands of a group of outside investors? Are the outside investors individual investors, whose names and backgrounds are provided? Or are they nondescript offshore corporations, identified only by their attorneys, agents and post office boxes. Remember, as a rule of thumb, professional investors are likely to be interested in seeing their shares increase in value, and then disposing of them. Are these stockholders registering their shares as part of the public offering? If so, you may be justifiably concerned that they are more interested in the short term price of the stock than the long term prospects of the Company. On the other hand, if members of management are large shareholders, and are not selling immediately, it may be reasonable to conclude that their priority is building the company
Use of Proceeds
The Use of Proceeds section tells investors just how the Company plans to use the offering proceeds. This is vital information. As you review this section consider whether it contains sufficient details about the planned spending. Will the funds be used to grow the business? Does the Company plans to spend the bulk of its proceeds developing its operations; building plants, expanding product lines or producing products? Will these expenditures result in immediate, or at least foreseeable, revenues? Some expenditures predictably will not. Spending on research and development may be necessary, but it is far more speculative and the results (and therefore the company’s prospects) are often far from certain.
Consider this also. Does the Company plan to use any of the proceeds to pay outstanding debts? Will that leave the company with sufficient funds to execute its business plan?
And finally, is the Use of Proceeds section just an illusion? Has the Company reserved the right to allocate the proceeds differently? If it has do you, as an investor, feel comfortable relying upon management’s judgment – or would you prefer to invest in a company that is committed to spending the offering proceeds in the way the Prospectus specifies.
Financial Statements
These appear at the end of the Prospectus, after your eyes are bleary, your mind is weary and your thoughts are drifting to something else. (Selected financial information may also appear throughout the Prospectus, in various tables as well as in the Management’s Discussion and Analysis).
Read the financials with care, and pay attention to the auditor’s footnotes, because these will explain significant entries on the balance sheets. The financial statements will reveal whether the company has suffered losses, and whether those losses have occurred from year to year. They will reveal the extent and nature of the Company’s assets. Are those assets tangible or intangible? Does the Company have cash and cash equivalents, or are its assets inflated by licenses, patents, goodwill and other intangible items? Are revenues consistent? Have there been any unusual expenses? Are salaries and expenses proportionate to revenues or are they excessive? Each of these factors should be carefully considered. It may seem simplistic, but from a financial standpoint the past is often prelude to the future.
As you can see, there is a wealth of information to consider and review in any prospectus. Hopefully, we have given you a starting point. The burden, however, is on you, the individual investor, to protect yourself by reading, reviewing and asking questions. As always, you, buyer, should be wary.
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