Study Notes: Prospectus

By Anish Sinha 18 Minutes Read

Introduction

The next stage after a company is incorporated is to raise the capital required to operate the firm. We now know that it is illegal for a private business to ask the public to purchase shares in it therefore, only in the event of a public corporation is it necessary to invite the public to subscribe for the share capital. The directors of a public business do not need to release a prospectus if they are confident in their ability to arrange the necessary capital privately.
A public corporation typically issues a prospectus in order to raise cash. The purpose of a prospectus, in addition to inviting investors, is to enlighten them about the company’s operations, finances, capital structure, possibilities for growth, management, etc.

Any document that lists the financial securities the company is offering for sale to potential investors is called a prospectus. The public firm may issue a prospectus itself or on its behalf. “Prospectus” means “any document described or issued as a prospectus and includes a red herring prospectus referred to in section 32[1] or a shelf prospectus referred to in section 31[2] or any notice, circular, advertisement or other document inviting offers from the public for the subscription or purchase of any securities of body corporate,” according to Section 2 (70) of the Companies Act, 2013[3]. Put simply, a prospectus is any document that requests deposits from the general public or offers from the public to buy firm shares or debentures.

A prospectus can be more than just an advertisement; it can also be a notice or a circular. If a document meets both requirements, it is considered a prospectus:

a) It must invite subscription to or purchase of shares, debentures, or any other security of a body corporate; 

b) It must be made available to the public.

Court in in Pramatha Nath Sanyal v. Kali Kumar Dutt[4], held that advertisement which state that some shares are still available for sale according to the terms of the company which may be obtained on application was held to be a prospectus as it invited the public to purchase shares. 

In Nash v. Lynde[5], the court clearly mentioned the fact that a prospectus has to be “issued to the public” in order to qualify. A solitary private correspondence is insufficient to constitute a public issue. Further in this case the court ruled that in this case when the managing director of a company sent multiple copies of a document labeled “strictly confidential,” which contained details about a proposed share issue. The co-director then forwarded a copy of the document to a solicitor, who then forwarded it to a client, who then forwarded it to a relative. As a result, a paper was secretly shared among the directors’ close pals. According to the House of Lords, there had been no public problem.

We must keep in mind that a prospectus is merely an invitation to offer rather than an actual offer made by the company. A business requests applications for the acquisition of its shares, debentures, or other securities by releasing a prospectus to the general public.
The share application form must be completed and submitted with the share application fee by those who wish to buy shares in the company.
By doing this, applicants are essentially making bids to the business to purchase the number of shares specified in the share application forms. In response to those share application forms; the company’s Board of Directors will subsequently allot shares.

Aims and objectives of Prospectus

• It is a formal and official notice that a new company has been formed.
• It serves as an official document outlining the terms and circumstances of the capital issue offered to investors.
• It functions as written documentation of the terms and circumstances surrounding the issuance of a company’s shares or debentures.
• It functions as a silent salesman and is a promotional tool for the selling of new issues.
• It’s a controlled advertisement, so imply that the seller beware.
• It holds all genuine documents pertaining to the matter and holds the directors accountable for any false statements made in the prospectus.

In accordance with Section 26 of the Companies Act of 2013, a prospectus’s contents must include the following:

i)                   Information to be included in a prospectus;

ii)                 Reports to be included in a prospectus;

iii)               Declaration;

iv)               Other items.

Type of prospectus

There are four different sorts of prospectuses, depending on the nature of the public offering and its value to both the public and a corporation. The following are the four types of prospectuses:

1. Abridged prospectus: An abridged prospectus is a concise document that summarizes a company’s prospectus, containing the most important details for potential investors. It’s defined in the Indian Companies Act, 201 as a memorandum that includes all the relevant features of a prospectus as specified by the Securities and Exchange Board of India (SEBI). An abridged prospectus is usually less than five pages long. It provides investors with essential information about a company’s financial standing, potential risks, and other relevant details. This information can help investors make investment decisions in a public offering and can also help a company attract investors and secure funding,

• More prominently, it is issued with the application form for securities.
• It is a requisite during Initial Public Offerings (IPOs).
• Mandatory when there’s a follow-on public offer (FPO).
• Even in rights issues to existing shareholders.

2. Shelf prospectus: Chapter 31 of the Companies Act[6] addresses Shelf Prospectuses. At the time of the first offer of the securities included therein, any class or classes of firms, as the Securities and Exchange Board may establish by regulations in this regard, may file a shelf prospectus with the Registrar, which shall indicate a No additional prospectus is necessary for a second or subsequent offer of securities issued during the period of validity of that prospectus [Section 31(1)][7]. The period of validity of such a prospectus shall not exceed one year and shall begin on the date of opening of the first offer of securities under that prospectus. A corporation is only permitted to issue a shelf prospectus if it is using non-convertible debt bonds to raise capital. One cannot convert a non-convertible debt bond into share capital. A business can raise money four times by issuing securities through the issuance of a shelf prospectus. The details provided in the shelf prospectus could change depending on the business and the money it needs. Nonetheless, the majority of shelf prospectuses contain details on the company’s history, a financial synopsis, the kind of security, the size and price of the issue, the quantity of securities, a risk assessment, a sector analysis, and more.

3. Red Herring Prospectus: The full details regarding the number and value of the securities are not included in the red herring prospectus. The red herring prospectus, in general, includes information on the company’s operations and functions as well as the prospectus itself, allowing potential investors to obtain the necessary data to make an informed decision. Three days before the list of subscriptions or offer, the red herring prospectus needs to be submitted to the relevant registrar.

4. Deemed Prospectus: The Companies Act’s section 25(1) explains deemed prospectus. As the name implies, it is merely regarded as a prospectus and, absent certain exceptional conditions, is not regarded as a fully legitimate legal document. When a business wants to offer certain securities through an intermediary and get around SEBI requirements, it usually needs to file a deemed prospectus. An issuing agency, stockbroker, or merchant bank can serve as this intermediary.

The following two circumstances must be met for a presumed prospectus to be regarded as an authorized legal document for the sale of securities 

• Condition 1: An intermediary is being used to sell the securities. Additionally, the intermediary received the shares from the issuing business and within six months presented the offer for sale to the public. It is assumed that the issuing business will in this case sell its securities to raise money from the general public.
• Condition 2: In the event that the intermediary issues a sale offer and the company that assigned the shares to them has not been paid for the stocks. According to the SEBI, this is an attempt on the part of the issuing business to offer stocks to the general public without first filing a prospectus. An intermediary then files a presumed prospectus after that.

Deemed prospectus legally requires the issuer to provide the relevant information to the relevant authority about an investment offering made to the general public. It makes it possible for investors to assess the risk involved in the transaction. Material information affecting the issuer’s responsibilities and financial stability must be provided. It contributes to preserving total transparency. The deemed prospectus protects an issuer against filing a prospectus by taking advantage of legal loopholes.

Regulations for structuring prospectus

Justice Kindersely established the “Golden Rule” for prospectus structuring in New Brunswick & Canada Rly. & Land Co. v. Muggeridge (1860).[8]
In summary, the rule is as follows: Those who publish a prospectus promise the public significant benefits that will be received by those who purchase shares in the planned venture. The public is encouraged to accept the representations made in the prospectus as true, Therefore, everything must be stated with exacting precision; nothing should be claimed as fact that isn’t true, and nothing should be left out whose existence could in any way compromise the quality of the benefits and tenets that the prospectus presents as reasons to purchase shares. In other words, it is important to reveal the genuine purpose of the company’s endeavor.

Court in Rex v. Kylsant[9] claimed that over a lengthy period of time, dividends of 5 to 8 percent had been consistently paid. In actuality, dividends had been paid from realized capital earnings for the seven years prior to the prospectus date, and the company had been suffering significant losses. The prospectus was deceptive and false, it was held. Even though the statement was truthful on its own, the context in which it was made was untrue.

Partial-truth, in this case, represented as a whole truth may tantamount to a false statement [Lord Halsbury in Aarons Reefs v. Twisa][10].

Thus, the persons issuing the prospectus must not only include in the prospectus all the relevant particulars specified in Section 26 of the Act, which are required to be stated compulsorily but should also voluntarily disclose any other information within their knowledge which might in any way affect the decision of the prospective investor to invest in the company.

Conclusion

To put it simply, a prospectus is any document that requests deposits from the general public or offers from the public to buy firm shares or debentures. To help investors make well-informed decisions about their investments in the issue, the prospectus must include all pertinent information that is adequate and true.

The prospectus shall contain all material information which shall be true and adequate so as to enable the investor to make informed decisions on the investments in the issue. The material facts disclosed in the prospect by the company must be true, it should not be a misleading, if any statement or the material facts disclosed falls or misleading than the persons who are directors at the time of issue of prospects, promoters of the company and the person who are authorized for issue of the prospects were held to be liable. Misleading not only amounts to a false statement of the material facts but also omission of any relevant fact also amounts to the misleading. In case of a misleading liability can arise both criminal and civil.

[1] Companies Act, 2013.

[2] Ibid.

[3] Dr. Niraj Kumar, Business Legislations, 2009, P-589.

[4] AIR 1925 Cal 714.

[5] (1929)

[6] Companies Act, 2013

[7] Companies Act, 2013 

[8] 1924 SCR 450.

[9] Rex v. Kylsant (1932)

[10] (1891. No. 1447.)

Anish Sinha