Understanding Draft Red Herring Prospectus

3 min read

The year 2021 was known as the year of Initial Public Offerings (IPOs).

With the launch of 63 IPOs in the India stock market, they successfully attracted around 

Rs.1 Lakh Crore IPOs are well-known for attracting the interest of investors and creating a big buzz in the market. However, it is quite evident that investing in every IPO out there in the market is not the right thing to do (read our previous post to understand factors to consider while choosing to invest in an IPO) .

With so many IPOs being announced by different companies on a regular basis, identifying the right company to invest in can become a challenge. The company’s DRHP is the one document shared by the company, which helps you assess the company’s potential and understand what they are offering.

What is a Draft Red Herring Prospectus?

A draft red herring prospectus (DRHP), also known as the offer document, is prepared by the merchant bankers as a preliminary registration document for companies looking to float an IPO for book building issues. It is filed with SEBI (Securities and Exchange Board of India) and the intention is to raise money by selling company shares to investors. The document essentially clarifies why the company wishes to raise money from the public, how the money will be put to use and the risks involved in investment.

Thus, this document includes information about the company’s financials, business operations, its standing in the industry it operates in, promoters, and listed or unlisted peers. 

Once filed, the SEBI DRHP is reviewed to note if adequate disclosures have been made. The observations are then communicated to the merchant bankers, who then make the suggested changes and file the final offer with Sebi, the ROC as well as stock exchanges like the BSE and the NSE. Further observations and changes at this stage can be implemented after reviewing the final document.

As an investor, here are a few things to look at in a Draft Red Herring Prospectus:

  1. Business Description:

This segment talks about a company’s core operations and how it conducts business. As a prospective shareholder, you should pay attention to this part as your investment will be utilized by the company in its core business and you will be entitled to hold ownership of this very part should you choose to become a shareholder.

  1. Financial information:

This is one of the most important segments and contains the company’s audit reports and financial statements. As an investor, the financial statement will help you get an idea of future dividends based on the profits disclosed. You can gauge the safety and profitability of your future investment based on the financial statement.

  1. Risk Factors:

Companies list out the potential risks that could impact their business and operations under a section titled ‘Risk Factors’. While many are routinely listed risks, some risks need to be scrutinized. As an investor, you should be able to read between the lines to identify the real risks that could pose a threat to the company’s growth in the future.

  1. Use of Proceeds:

Companies announce IPOs for various reasons. Find out what the company intends to do with the capital it raises through the IPO. Does the company plan to reduce its debt, purchase new assets or meet its working capital needs? Also check the capital structure of the company to see if any big private investors have put money into the company.

  1. Industry overview:

A red herring prospectus carries information about the position of the company, relative to its competitors. The performance trends of the industry to which the company belongs to is also included in the document. If you are looking forward to a particular company’s IPO, you should analyze the various business and economic variables at play, the demand and supply mechanism and the future prospects.

  1. Management:

A company’s prospects have a lot to do with the people who run it. The management is responsible for planning strategies on varied fronts like driving growth, pushing expansions, renovation, marketing etc. This section has details such as names, qualifications, designations about directors, promoters and key management personnel. It may also have information about any criminal cases or that of financial delinquency or pending litigations against these people.

Why is the Draft Red Herring Prospectus (DRHP) important for investors?  

The DRHP is considered to be the most important document for investors interested in IPOs. One of the primary reasons for that has to do with the amount of information that it reveals about the company. Just reading through the document can give you all of the information that you require to make an informed investment decision. 

When conducting an analysis of the company that filed for an IPO, make sure to read through all of the sections listed above. In addition to that, you should also take a look at the company’s management, their experience, and skill set. Also, it is crucial to go through the industry overview as well, since it can tell you a lot about the environment that the company is operating in.

That said, considering the fact that a typical DRHP can range anywhere from 300 to 500 pages, it may not be practical to read through the entire document. In such case you can have a quick glance at the research page of ShareIndia website (click here), where ShareIndia Research Team keeps on posting the details of the upcoming IPOs with the expert advice whether it is suitable for you or not.

Disclaimer: Any Advice or information in the post is general advice for education purpose only and is not responsible for generating any trading profits for anyone, please do not trade or invest based solely on this information.

Leave a Reply

Your email address will not be published.