Legal Definitions - red-herring prospectus

A red-herring prospectus is an initial, preliminary version of a legal document that companies provide to potential investors when they plan to offer new securities (like stocks or bonds) to the public. It's called "red-herring" because it typically contains a prominent disclaimer, often printed in red ink, stating that the information is not yet final and the securities cannot be sold until the offering is officially approved by regulatory bodies, such as the Securities and Exchange Commission (SEC) in the United States.

The purpose of a red-herring prospectus is to allow the company and its underwriters (the financial institutions helping to sell the securities) to gauge investor interest and gather feedback before the final terms of the offering are set. It provides a substantial amount of information about the company, its financials, its business operations, and the proposed offering, but key details like the final price of the securities or the exact number of shares being offered may still be missing or subject to change.

• Example 1: Tech Startup Initial Public Offering (IPO)

  A fast-growing tech startup, InnovateCo, decides to go public. Before finalizing its initial public offering (IPO), InnovateCo's investment bankers distribute a red-herring prospectus to institutional investors and potential buyers. This document outlines the company's impressive growth, its innovative software products, its management team, and its financial history. However, it clearly states that the exact IPO price per share and the total number of shares to be offered are still under discussion and subject to change based on market feedback and regulatory approval.

  This example illustrates how a red-herring prospectus is used in an IPO to provide initial information and gauge interest from potential investors before the final terms of the offering are set and regulatory approval is obtained. The disclaimer ensures investors understand that the details are not yet final.

• Example 2: Established Company Issuing New Bonds

  Global Manufacturing Inc., a well-established company, plans to raise capital by issuing new corporate bonds to fund a major expansion project. To test the market and attract potential bondholders, Global Manufacturing Inc. releases a red-herring prospectus. This document details the company's strong credit rating, its stable revenue streams, the purpose of the bond issuance, and the general terms of the bonds (e.g., maturity date, interest payment frequency). However, the specific interest rate (coupon rate) and the final offering amount are left open, pending discussions with large institutional investors and final SEC clearance.

  This example demonstrates the use of a red-herring prospectus for a secondary offering (bonds, rather than just stocks) by an existing company. It highlights its role in gathering interest and providing preliminary information about the debt offering before the final terms are locked in and regulatory approval is secured.

• Example 3: Real Estate Investment Trust (REIT) Offering

  A new Real Estate Investment Trust (REIT), Urban Properties REIT, is being formed to acquire and manage a portfolio of commercial properties. To attract initial investors, Urban Properties REIT issues a red-herring prospectus. This document describes the types of properties the REIT intends to acquire, its management strategy, the projected dividend payout structure, and the risks associated with real estate investment. It explicitly states that the final list of properties to be acquired and the exact share price for the REIT units are still being determined and that the offering is contingent on regulatory approval.

  This scenario shows the application of a red-herring prospectus for a specialized investment vehicle like a REIT. It underscores the preliminary nature of the information provided and the necessity of regulatory approval before the investment units can be officially sold to the public.