How to read an IPO prospectus

What to look for

• The split between shares sold by the company and shares sold by existing holders, which is the first sign of whether the offering raises money for the business or lets insiders out.
• The price per share, or the estimated range in a preliminary prospectus, and the exchange and ticker.
• The underwriters named at the foot of the page: by convention the first names are the book-runners, who set the price and allocate the shares.
• A line saying the company is an emerging growth company, and often that it is a controlled company or a foreign private issuer, each of which relaxes some rule that protects new shareholders.
• On a final prospectus, the registration file number in the top corner, which ties it to the S-1 or F-1 it belongs to.

Questions worth asking

• How many shares are being sold, by whom, and at what price?

What to look for

• The one-paragraph description of what the company sells and to whom, which everything after should be tested against.
• The operating metrics the company chooses to lead with, since a company picks the numbers that flatter it and those metrics will recur in every later report.
• The summary financial data that usually ends the chapter, which is the first sight of revenue, growth and losses over the last two or three years.
• The offering summary table, which usually restates the terms and adds the share classes and their votes.

Questions worth asking

• In plain language, what does this company sell, who buys it, and how does it make money?
• Which operating metrics does the company choose to highlight in its summary?

What to look for

• Risks written in the past tense or the present tense, such as "we have incurred net losses" or "we depend on", which describe the company as it is.
• Customer, supplier or platform concentration, with the percentages the company gives.
• Risks about the offering itself: dual-class control, the lock-up, dilution, and the absence of a prior market for the shares.
• Regulatory risks the company already lives under, as opposed to rules that might one day change.
• A history of losses and a statement of how long the cash will last, which together say whether this offering is a choice or a necessity.

Questions worth asking

• Which risk factors state a fact about this company rather than a possibility?
• Does the company disclose customer, supplier or platform concentration, and at what percentages?

What to look for

• The net proceeds to the company after the underwriters’ discount, and whether the company receives anything at all from shares sold by existing holders.
• Specific uses named with amounts: repaying a loan, funding tax withholding on employee stock, paying a dividend to pre-IPO holders, or buying a business.
• The phrase "general corporate purposes", which usually means the company has no specific plan for the money.
• Whether any of the proceeds go to affiliates of the underwriters, which the underwriting chapter must flag as a conflict of interest.

Questions worth asking

• What will the company do with the net proceeds, and does any of the money go to insiders or lenders?

What to look for

• The pro forma net tangible book value per share after the offering against the offering price, and the dilution per share to new investors that follows from them.
• The table of average price paid: existing holders often paid a small fraction of the IPO price for most of the shares.
• Options, restricted stock units and convertible instruments outstanding, which the dilution table usually leaves out and which are the real overhang.
• Debt that converts at the offering, which changes the share count on the day the deal closes.

Questions worth asking

• What is the dilution per share to new investors, and what did existing holders pay on average?

What to look for

• The company’s definition of each operating metric it leads with, and whether the definition would survive a skeptical reader.
• Revenue by product or by geography where it is given, and the trend in gross margin.
• Stock-based compensation, which is often enormous around an IPO and can turn a modest operating result into a large reported loss.
• Liquidity: cash on hand, debt, and the company’s own statement of how long its resources last.
• The critical accounting estimates, where the company says which judgements most affect the numbers.

Questions worth asking

• How does the company explain its revenue growth and its losses over the periods shown?
• How does the company define the operating metrics it reports?

What to look for

• The competition section, where the company names its rivals and the basis on which it claims to win.
• Customers named or described, and the terms they buy on, since the risk chapter or the segment note will have told you whether any of them is 10% or more of revenue.
• Suppliers, manufacturers and platforms the company depends on.
• Intellectual property and regulation, which say how defensible the business is and who can change its rules.
• Headcount and its growth, a simple measure of how fast the company is spending.

Questions worth asking

• Who does the company name as its competitors, and how does it say it competes?
• Which suppliers, manufacturers or platforms does the company depend on?

What to look for

• The tenure of the leadership team and whether the founders still run the company.
• Board independence and the committees, and whether the company relies on the controlled-company exemption to skip an independent majority.
• The summary compensation table, and any one-off awards granted in connection with the offering.
• Related-party transactions, in the chapter that follows: loans to officers, deals with the sponsor, and the terms of any agreement with a controlling holder.

Questions worth asking

• Who runs the company, how long have they been there, and how are they paid?
• Does the prospectus disclose any dealings between the company and its officers, directors or major holders?

What to look for

• Each holder of more than 5%, with their stake before and after the offering, and the voting power that goes with it when there is more than one class of shares.
• Which holders are selling, and how much: a founder or a sponsor selling a large slice at the IPO is worth noticing.
• The votes per share of each class, in the Description of Capital Stock that follows, and any sunset on the high-vote class.
• Lock-up terms in Shares Eligible for Future Sale: how many shares can be sold, and when, once the offering has closed.

Questions worth asking

• Who will control the voting power after the offering, and which holders are selling shares in it?
• When does the lock-up expire, and how many shares become saleable then?

What to look for

• The auditor’s report, and whether it carries a going-concern paragraph.
• Revenue recognition in the first note, which says when the company counts a sale.
• The stock-based compensation and equity notes, which explain the share count and the awards that will vest after the IPO.
• Debt and its terms, including anything that converts or comes due on the offering.
• The segment note, if the company reports more than one, which the Business chapter should match.

Questions worth asking

• Does the auditor’s report raise substantial doubt about the company’s ability to continue as a going concern?
• How does the company recognize revenue, and what does the stock-based compensation note say about awards vesting after the IPO?