Whether you are looking at a new IPO or researching an existing public company, reading the prospectus is an invaluable tool to learn more about any company.

Here are some of the things you should pay particular attention to when reading a prospectus. As a general rule, however, you should read all of the prospectus and not just the highlighted parts set out below:

Summary information

The summary provides an overview of those matters more fully disclosed in the prospectus and audited financial statements. Read the fine print in the footnotes.

Risk Factors

Every prospectus will have this section and contain many of the same risk factors and disclaimers in every prospectus. However, still pay attention since many risk factors will be different. As well, if any representations made to you are inconsistent with the risk factors set out in the prospectus, then be skeptical about the verbal statements made to you. Each risk factor should be highlighted and  more fully discussed elsewhere in the prospectus. As such, follow-up and try to locate each one.

Recent Developments

This section will give you an update as to recent developments affecting the company.

Litigation Section

Where there is ongoing material litigation, you will see this section. If not in the prospectus, then the company is representing that there is no ongoing material litigation. This is an important consideration that could have a large impact on the business of the company if the dispute centres around a major component of the company or is for a great deal of money.

Company Section

The company section gives the history, type of operation, location(s) of operations, and general business plan. This information is expanded in a subsequent section entitled "Business."

Use of Proceeds

This section is very important since this will indicate how funds raised are to be used. Beware of any company that does not adequately tell you what it is doing with the money.

Capitalization Table

A capitalization tabled gives the actual and pro forma (adjusted) financial position of the issuer before and after it receives the funds from the offering. Review the table and its footnotes very carefully.

Dividend Policy

This will tell you whether the company plans to pay out dividends. If you are looking for regular income, then any dividend policy stating that it will not pay out dividends, is not a company you should be investing in. If you are looking for a growth company, then the company should indicate that it has no track record of dividend payments and does not intend to pay dividends.

 Dilution Section

This section contrasts the price per share paid by existing shareholders with the present offering price and contrasts the per share tangible book value (the value you will receive in your shares after the offering) with the offering price (that you will pay for those shares).

Selected Consolidated Financial Data and Management Discussion and Analysis of Financial Condition and Results of Operations

The selected consolidated financial data should be read with the "Management's Discussion and Analysis of Financial Condition and Results of Operations." The consolidated financial information expands upon the financial information contained in the summary information, but substantially less than that found in the financial statements and footnotes.

The management discussion and analysis of financial condition and results of operations is very important. This section will tell you how management feels it has performed and where it is going. This section will give you a feel of the financial trends of the company relating to its revenues, earnings and expenses. It will tell you where the company is heading after the new offering. Read it very carefully.

Business Section

The Business section will give a tremendous amount of information about the company, its products, its history, business plan, its strategy and method(s) of operation. It will also contain a subsection entitled "Competition"  which outlines who its competitors are. This is important especially where the company is taking on a large competitor who has dominated the market which the issuing company is trying to penetrate. This section will also have additional subsections such as Proprietary Rights, Employees, and Legal Proceedings.

Management

The Management section gives you a list of the directors and executive officers, and gives their ages, positions and past experience. There will be references to compensation plans, and special arrangements with employees such as stock option plans. Where the employees and officers have options to purchase a large amount of stock, this could result in the price of the stock falling due to share dilution.

Principal and Selling Shareholders

This table will provide you with information with respect to the beneficial ownership of our outstanding common shares before the offering and after. It is important because it gives you an indication of whether the current shareholders feel that keeping the stock is worthwhile. If many insiders are unloading their stock, be skeptical of the offering.

Certain Transactions

This section will highlight transactions in which insiders have been a party to with the issuing company. Read carefully since such transactions will have the effect of the company paying out its revenue to these insiders and away from the business. This could include loans to insiders and service contracts with insiders.

Description of Capital Stock

This section describes the classes of stock, their voting rights and dividend entitlements. The section also indicates which securities are authorized, issued and outstanding.

Underwriting

The underwriting section discloses the form of underwriting used and the amount of compensation the underwriter will receive. An underwriter's commitment to buy all the shares from a company and to become
financially responsible for selling them is called a firm commitment. In a best efforts underwriting, the underwriter only promises its "best efforts" in selling shares to the public. Under a best efforts underwriting, the underwriter does not guarantee that all the shares offered will be sold, and therefore, does not assume any financial liability.

Legal Matter and Experts

The legal matters and experts sections describe who performed the legal work on the offering and which accounting firms and other professionals participated. Parties listed in legal matters and experts have third-party liability in connection with the offering.

Report of  Independent Auditors

This report is the auditors' opinion which should be read to determine whether there are any qualifications relating to management reporting practices that do not conform to generally accepted accounting principles. Read all footnotes.

Warning Signs

• Bad news in the Recent Development Section

• The investment banks hired by the issuing company are not well known or well regarded. The investment bank must do a great deal of due diligence, so it's always reassuring when a well known investment bank is conducting the due diligence.

• Large number of shares in the offering is coming from selling stockholders. It usually means that the original shareholders are bailing out.

• Proceeds of offering are used to pay off debt or pay original shareholders large bonuses or dividends. Proceeds should be used to build and invest in the company’s future not line the pockets of insiders.

• Declining revenue or margins. Revenues and margins of companies who want to go public should be on the increase, not on the decline. Look at all financial ratio trends to see other financial warning signs.

• Reliance on one large client for business. If the company relies on one customer, things will go quite badly if that customer disappears later on unless the company has broaden its customer base.

• Competing against a major player. In the Competition section, the company will list its competitors. If for example the company is developing a computer operating system to compete directly with Microsoft, it would not be a good idea to invest in the company.

• Litigation disputes. Dangerous litigation doesn’t help a company.

• Lucrative Management Compensation Packages. In a newly public company money should be invested in the company and not being used to line the pockets of executives. If the company does well, then the management team should be compensated afterwards but not before then.

• Going Concern Statement in the Report of the Independent Accountants. If the company’s auditors state the company’s business results raise "substantial doubt about the firm's ability to continue as a going concern", be concerned. It usually means that a company needs the IPO money to continue to pay off its debt.

• Sweetheart deals. From the "certain transactions" section you can determine what kinds of related transactions are being engaged in by management and the issuer's principals. Is there an attempt to siphon off funds and line management’s’ pockets.

• Unexplained change in accounting methods. Certain accounting practices or changes will be disclosed in the footnotes to the financials. These practices or changes may make revenues and expenses appear different from what they really are.

• No stated business purpose or plan. Without a plan or purpose you have no idea what the company is all about.

• No specific use of proceeds. You need to know where the IPO proceeds are going.

• No specific restrictions on the use of the funds.

• Inexperienced management. A good company needs good experience management.

• Little or no operating "track record."  Unless you know a company’s track record, you will have no idea what you are buying into.

• Unusual Risk Factors. Always read the risk factors section with acute attention and look for risk factors that are not part of the traditional boilerplate provisions that all prospectuses have.

Remember that the securities commission never gives its opinion on the truth or accuracy of the prospectus or the merits of the underlying security.

This is not a comprehensive list. Always ask your broker for his advice and opinion regarding the IPO and if you do not understand anything, then do not be afraid to ask question.

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