Spring 2022 End of Semester Exam on Company Prospectus- Accounting, University of Georgia
List the main components of a prospectus in the order in which they appear based broadly on UK legislation. Give a brief comment on the importance of each.
- Description of the share capital of the company and a statement of the indebtedness of the group including contingent liabilities, guarantees, and commitments.
- The full names of the directors of the company and a list of the other parties (chiefly professional firms) involved in the issue
- History and business of the group, including background industry information and an explanation of what makes the group tick, with details of the main commercial factors governing its operations and future prospects.
- Directors, management, and staff
- Past results and forecasts of future profits and dividends
- Balance sheet and interests in properties
- Reasons for the issue, use of proceeds, and statement of working capital
If the flotation is by way of a new issue, the description of the share capital should include the effect of the issue of the new shares. The impact of any options outstanding, the exercise of any warrants, and the conversion of convertible securities should also be set out.
Information on indebtedness has to be obtained independently from the banks concerned and this information takes time to collect and verify. Preparations should be made so that the figures are as current as possible, normally as at a date no more than a month before the date of the prospectus.
There is no one 'correct' level of borrowing. An apparently high level of gearing may deter some potential investors but assurances on the adequacy of working capital are given elsewhere in the document. If the flotation raises new funds for the company and one of the purposes of going public is stated to be to reduce borrowings, this should make good sense to investors. In general, however, reduction in borrowings is considered by the market to be one of the less exciting reasons for going public.
This part is straightforward descriptive material, although it would be a mistake to under-estimate directors' ability to change even the most basic information presented about themselves Written consent must be obtained from any professional firm whose opinion is given or who are quoted as experts for the use of their name in the form and context in which it is included
In order to give investors a general appreciation of how the group has evolved. there will be a few paragraphs prepared by the company's executives and edited by professional advisers which will summarize the origins of the business and its development to the present day.
The potted history is followed by a lengthy descriptive section, covering in general terms the various activities, countries, products, and business conditions that are relevant to the operations of the company and its subsidiaries. Different product lines and divisions should be explained and a geographical analysis of production, sales, and operating profit may be given Commercial aspects such as retail networks, agencies, distributorships, brand names franchises, licenses, patents, and research and development capabilities should be discussed depending on the type of business, Critical relationships with customers should be mentioned. For example, could the supply of key components restrict output? Do sales to any individual customers represent a significant percentage of the output of the group as a whole or of an individual product line or division?
This section provides the directors of the company with their main opportunity to get across the spirit and traditions of the company Although the wording used, as is the case with the whole prospectus, is subject to strict legal scrutiny this section tends to be less dry than the remainder. A little pride in achievement is allowed to show through.
Details should be given of the experience and areas of responsibility of distinguishing between executive and non-executive. Investors will also be interested to know something about senior management below the director level and be assured of the depth and professionalism of the management team, in general. Any profit-participation or share-incentive scheme in operation or planned should be mentioned. Information on other employees may also be relevant, particularly for groups with large labor forces. Some comments on labor relations may be helpful.
The audited results and other financial information for a certain period. commonly five years will be set out in the accountant's report. The report will include such notes as the auditors feel necessary to explain the figures in an objective way.
In the body of the prospectus, the directors of the company may wish to add their own comments and explanation of the past trend or of any special circumstances which might distort a particular year's figures. As well as giving background information, it is essential to anticipate any perception of weakness derived from the past record which could shed doubt on the forecast of profit. The major assumptions for the profit forecast will be listed and reviewed elsewhere in the prospectus by the auditors and merchant banks. Again, the directors may feel that the reader would be helped by further background comment in addition to the statement of the bare assumptions
It is appropriate for the directors to make a statement of their policy on dividends. There is little reason for a private company to be concerned about the consistency of dividend payments or indeed, depending on the tax position and requirements of the shareholders, about dividend payments at all. Consequently, the past record of dividends may be of little guidance to future policy
Depending on the time of year when the company is floated, the first year's dividend payments may well be less than if the company had been a public company throughout the relevant financial year. The directors must therefore spell out not only their immediate intentions for the first period, but also how this may be validly scaled up for a full year's payment.
The amount of dividend to be paid will depend on a number of factors including the company's own need to retain funds for future growth. Very often a market will have fairly specific expectations of a dividend yield appropriate to a company in a particular sector in a particular market Occasionally there is a target yield in a market irrespective of the type of company.
The directors will wish to maintain future dividends at no less than the initial level. A dividend cut is widely interpreted as evidence of management failure. even in cyclical industries. The most widely used measure to assess whether a dividend can be maintained is the number of times it is covered by earnings. Some particularly stable components of earnings, such as rentals receivable under long-term leases or interest on bonds, may be weighted more heavily. A dividend cover in the range of one and a half to two times may be considered comfortable.
The latest audited balance sheet of the company and the group with supporting notes will form part of the accountant's report Directors may feel some commentary on the balance sheet and planned capital expenditure is helpful Il a group is made up primarily of asset-intensive businesses such as property or shipping, it may be required and in any case, be desirable to show up-to-date valuations of its major assets carried out by an independent professionally qualified valuer If the valuations show significant differences from book value either surpluses or deficits) an adjusted statement of net assets incorporating the valuations should be shown in this section. Any significant tax consequences of disposals at the valuation figures should also be shown. It is not necessary for the valuations actually to be written into the books of the companies concerned. If they are, tax problems may arise and the charge for depreciation may increase, reducing reported profits
If existing shares are being sold to raise money for shareholders, no proceeds are received by the company However, if new money is going into the company the reasons why it is being raised and the uses to which it will be put should be spelled out In either case, a short statement is required from the directors stating that the group has sufficient working capital for its present requirements This is usually interpreted to mean that detailed cash flow projections have been carried out covering a period of at least 12 months from the date of the prospectus. In this part of the prospectus, a few words are likely to represent several weeks of investigation and analysis.
Name some of the appendices that are included in a prospectus
- Accountant's report on the group
- Summary of professional valuations
- Reports on profit forecast
- Statutory and general information
The accountant's report forms one of the main building blocks of the prospectus. Once the companies forming the basis of the flotation have been selected, it is the first significant piece of work to be put in hand.
The report will list the companies being examined and summarize the accounting policies used to prepare the accounts. The profit and loss account for past periods, commonly five years, will be shown together with notes. A statement of net assets of the company and of the group at the latest available date and, depending on requirements, for a number of years past will also be given, again with all relevant notes, Statements of sources and uses of funds and adjustments for the effect of inflation may also be included.
The formal report is addressed to the directors of the company to be floated and to the merchant bank. It is normally produced in draft form as soon as possible to highlight any potential snags in the flotation. At the same time, the accountants may be carrying out a more detailed investigation into the group for long form report, which is not for publication. Depending on the complexity of the group, the report for inclusion in the prospectus may take up to, say, three months to finalize.
Professional independent valuations of assets may be required by law or by stock exchange regulations. The directors of the company may in any event decide would be desirable to show the financial position of the group taking into account revaluation of assets. In these cases, letters from the valuers giving the basis of their valuation and a summary of the results of their valuations will be an out in an appendix. In the case of a property company, relevant details of use and development areas, tenure, planning permissions and tenants' leases will be given, depending on the nature of the property. The feasibility of the flotation of a property company and pricing will depend principally on the valuation
Assuming a profit forecast is made, the assumptions underlying the forecast will be set out. The accountants will review the accounting policies and calculations for the forecast.
They will check that the forecast has been properly compiled on the basis of the assumptions made by the directors and that the profit does not include any items which arise owing to a change in accounting policies.
The merchant bank will discuss with the directors of the company whether the basis and assumptions used for the forecast are realistic and comprehensive. Following these discussions they will write to confirm that the forecast has been prepared after due and careful enquiry.
Letters from the auditors and merchant bank to this effect will be included in the appendix. The letters always state that despite the involvement of the professional firms the forecast is the sole responsibility of the directors of the company. This can make them feel rather lonely.
It may be argued that the assumptions listed in this appendix are virtually meaningless. They may be couched in sweeping terms and therefore unlikely to be fulfilled in all respects. They also tend to deal more with general conditions or trends in the economy, such as interest, taxation and exchange rates than with specific commercial factors which have more meaning to a reader and a much more immediate effect on the company's business. It is countered that the most critical commercial factors cannot be set out without giving too much away to competitors.
This appendix a prepared chiefly by the lawyers and deals with legal and regulatory points not already covered elsewhere in the prospectus. The main headings are likely to include the following
-Details of incorporation of the company and share capital history including any reorganisation carried out in anticipation of the flotation
-A list of the company's subsidiaries and associated companies giving share capital, date of incorporation, and percentage owned by the group
-Arrangements for underwriting including circumstances in which the underwriting contract could be cancelled and an estimate of the other major expenses of the issue, together with a statement of the net proceeds.
-Disclosure of interests. This is a wide-ranging section and is basically intended to cover details of shareholders or directors' interests which might have some bearing on an investor's decision to invest Obvious points include who the major shareholders are and the extent of their shareholding, whether any directors are selling shares, any service contracts the directors have and whether they are parties to any other contracts with the group. A number of other factors may be relevant, depending on the circumstances of the case. A rather cynical definition of what is material for disclosure is anything which one of the promoters does not wish to disclose. Some statement about the controlling shareholders' future business dealings with the group may be relevant at this point.
-Summary of relevant provisions of new articles of association. A company going public will adopt new articles of association which are available in full for public inspection Relevant sections will be summarized in the prospectus. These will include clauses regarding voting rights of shares, procedures for changing the share capital and for the transfer and issue of shares, any restrictions on the company's ability to borrow money, and a summary of the directors' powers.
-Material contracts entered into by the company and its subsidiaries over some previous period, say the two years before the date of the prospectus Some contracts may be sensitive from commercial or other viewpoints. What is and is not a material contract is often the subject of one of the more lively debates to take place during the preparation of a prospectus.
List and explain what a typical timetable for a flotation based on the four-month period would be.
Note. I mean "Impact Day, the first day on which the detailed terms of the issue are made known to the market and to the press. This is earlier than the date of the prospectus and considerably earlier than the start of trading in the shares on the stock market.
|Date (in days)||Event|
|1-120||First planning meeting held Decision taken in principle. Merchant bank appointed. Estimated expenses discussed.|
|1-110||(i) Package of companies/businesses/assets to be floated decided on.
(ii) Accountants instructed and begin work.
(iii) Lawyers instructed and begin work.
(iv) Detailed timetable and list of responsibilities circulated to those involved.
|1-90||(i) Progress and possible problems reviewed with accountants.
(ii) Property valuers instructed if appropriate.
|1-60||(i) Draft accountant's report, property valuation and profit forecast available.
(ii) Basis of issue reviewed by company and underwriter.
|1-50||(i) Outline typewritten proof circulated to parties involved in the issue.|
(ii) Drafting and other work progresses.
|1-40||(i) Drafts of application form, share certificate, underwriting agreement and other documentation available.|
(ii) Receiving bankers, registrars and printers appointed.
|1-34||Drafting meeting to discuss documents before first printed proof is produced.|
|1-30||Record date for borrowings and disclosures.|
|1-27||First printed proof circulated, discussed by company and its advisers and sent for re-proofing.|
|1-20||(i)Second proof circulated to advisers and other interested parties (including the stock exchange) discussed and sent for re-proofing.|
(ii) Confirm flotation date with stock exchange.
|1-13||(i) Third proof circulated, discussed and sent for re-proofing Further proofs as required.
(ii) Verification process commenced.
|1-6||Final proof prepared and circulated to all relevant parties. Final comments obtained.|
|1-1||(i) Board meeting to approve prospectus and fix price.|
(ii) Underwriting proofs available.
|IMPACT DAY||(i) Press announcement of issue.|
(ii) Sub-underwriting letters sent out.
(iii) Bulk printing ordered.
|1+7||(i) Prospectus signed and other formalities complied with.|
(ii) Prospectus advertised and distributed to the public.
|1+12||Application lists open and close.|
|1+16||(i) Press announcement of overall results and basis Of Allocation.|
(ii) Underwriters' liability (if any) crystallized.
(iii) Stock exchange grants listing.
The details of the above timetable will vary according to local regulations In particular, the arrangements for and timing of settlement of dealings can differ sharply from market to market.
In parallel with the drafting of the documentation goes the preparation for the launch Promotional and marketing efforts are becoming more elaborate. Assuming a successful issue, the promoters will start to consider what basis of allocation to adopt.