Flotation by the big players will be analysed to death by the professionals, says Alistair Blair. But what should investors look for in a smaller company's prospectus?
In 1720, the South Sea Bubble got going and set the public off in a great mania of speculation. Some genius issued a prospectus inviting subscriptions to 'A company for carrying on an undertaking of great advantage, but nobody to know what it is'. He is said to have taken £2,000 on the first day, following which he caught the next tide to the Continent and was never heard of again. His inspiration lives on. True, prospectuses now supposedly include everything that investors ought to know about the companies they are investing in. But a few pages of unread print aren't going to come between a good salesman and a gullible investor's wallet.
If the company is like the Halifax, the Northern Rock or any other flotation worth £500 million or more, you're not going to add much to your understanding of the enterprise by ploughing through every last page. Anything of significance should already have been tracked down by analysts and highlighted in the press.
But inevitably, professionals give smaller companies less, and less careful, attention. If the new issue you are considering investing in is worth less than £100 million, you should make it an iron rule to flick through every page in the prospectus, checking for certain vital details as you go.
There are a couple of obvious checks that even the most unobservant of investors should make as a matter of course. First, it is important to see how much brokers are being paid for the flotation. You should satisfy yourself that only a modest fraction of the overall sum is going to be spent on fees. A general rule of thumb is that the higher the proportion spent in fees, the poorer the company's prospects. Second, it is essential to check that the flotation is being underwritten. Some of the smaller scale attempts at flotation are not.
Of the shares being sold via the prospectus, it is also important to know how many are new shares, the proceeds from which will go into the company, and how many are existing shares, being sold by shareholders who will put the proceeds into their own pockets. You'll find this information upfront on a page headed Key Statistics. A few pages further on, make a point of looking for a paragraph headed Use of Proceeds and check whether any loans are to be repaid from the flotation. Anyone other than a bona fide bank being paid off in this way is just as much a seller as someone selling existing shares. If most of the flotation money ends up in the pockets of existing backers, ask yourself if you should be buying something they are so keen to sell.
Never invest in a prospectus that doesn't include a clear pro forma statement of net assets, which will normally be in an appendix. If you study this carefully, including the nearby paragraph which summarises the company's borrowings, you should be able to figure out just how much the company needs your money. It's not unusual for small companies to float because alternative sources of capital have dried up.
Also make sure you have a look at the appendix headed Directors' and Other Interests. If you can work out the total cost of board pay as the money goes in, compare that with what they earned last year - you could be surprised by how often salaries go soaring up on the prospect of the arrival of outsiders' money. And how long are any service contracts? What proportion of any money being raised would disappear if these had to be paid off? In the same section, check out how much non-founders will be investing via the prospectus. For instance, junior directors with small shareholdings should be seen to be taking this opportunity to invest non-token amounts.
The Material Contracts section is also useful. It normally comes towards the end of the prospectus and covers the company's 'out of the ordinary course of business' dealings going back for two years. Anything could crop up. Satisfy yourself that there's nothing buried here that ought to have been more fully detailed in the main text. And finally, check up on the total cost of flotation which is invariably to be found in the General section of the prospectus.
Prospectuses are often appallingly difficult to comprehend, but a thorough reading could have enabled sharp observers to spot some of the worst recent abuses. It might just save you from investing in the next 'undertaking of great advantage'.