Initial Public Offerings (IPOs) attract the interest of lakhs of investors and many even create a huge market buzz depending on the size of the IPO. In recent years, due to the launch of multiple IPOs by different companies in India, investors often find it difficult to identify the right IPO to invest in. This is when assessing a company’s Draft Red Herring Prospectus (DRHP) can help investors in gauging the true potential of the company and in understanding the actual offering.
Here, we will explain the concept of DHRP in detail, along with demystifying the difference between DHRP and Red Herring Prospectus(RHP).
What is a Draft Red Herring Prospectus?
To reduce the level of risk in an equity investment, investors must review all the facts and details surrounding it before investing. Before investing in a company’s initial public offer (IPO), it is therefore important to analyze its Draft Red Herring Prospectus (DRHP).
DRHP tells us about company financials, quality of management, current valuation based on its present and past performance and all other details needed to make an informed investment decision.
A DRHP is divided into different sections. Here are some of the important components of a DRHP:
Use of IPO proceeds
Companies come up with IPOs for different reasons. This section mainly addresses questions like:
- Have any big private investors invested in the company?
- What is the current capital structure of the company?
- Why does the company intend to raise capital through an IPO?
- What are the company’s plans to reduce existing debt?
- Does it have plans to purchase new assets?
- How will it meet its working capital needs?
Business description:
This section states the company’s:
- Core operations
- The way the company conducts business
From this section, prospective shareholders can learn how their potential investment will be used by the company to carry out its core business. This is crucial information since investors will be entitled to have ownership of the core operations if they become shareholders.
Financial information:
Considered being one of the most important sections of a DRHP, the financial information segment contains audit reports and financial statements.
Every investor must look at the financial statement to get an idea about future prospects of dividends as per the profits disclosed. It also provides insight into the safety and profitability of the potential investment that an investor plans to make.
Risk factors
In a DRHP, companies list the potential risks that may impact current business and operations. This section is called ‘Risk Factors’. Some of the risks listed here may be routine for the industry, but certain risks must be closely scrutinized by investors.
Suppose an investor finds out that the company has many open legal cases. In such cases, it is sensible to avoid investing in the IPO. Investors must be able to read between the lines to know the real risks that can stunt the company’s future growth prospects.
Industry overview:
A draft red herring prospectus contains information about the company’s position vis-à-vis its competitors. It also includes details about the specific industry trends. Investors looking to invest in an IPO should analyze the different business and economic aspects at play, apart from the demand and supply functions that help in gauging the company’s future prospects.
Management:
A company’s future prospects are largely influenced by the people who are responsible for its day-to-day functioning. The management is therefore responsible for:
- Strategic decision-making
- driving future growth,
- Expansion plans,
- marketing, etc.
Under this section, investors can look at details like names of the people in the company’s management, their qualifications, what designations they hold, the company’s directors, promoters and other important management personnel. This section of the DRHP also contains information about any criminal cases or pending litigations against the company’s management.
Key differences between red herring prospectus and DRHP
Some of the main differences between a DRHP and RHP are:
| Draft RHP | RHP | |
| Meaning | A DRHP is a preliminary version of a RHP. It is created before finalizing the full prospectus. | A Red Herring Prospectus is an offer document that is finalized and filed by a company with SEBI (Securities and Exchange Board of India) at the time of making a public offer for sale of its shares for the first time. |
| Content | It contains high level details of the company’s business plan, financial standing and summaries of its major offerings. | A red herring prospectus contains full details about the company that an investor needs to know before investing in the company. |
| Alternative use | It is shared with the public only before an IPO. | Red herring prospectus can be used by a company that is already public and wants to give an overview of operations to potential investors. |
| Review and approval | DRHP can be reviewed by internal company accountants before releasing to the public. However, since this is a draft, it cannot be filed with SEBI. | For a RHP to be approved by securities regulators it must be reviewed by professional accountants. |
Conclusion
Both the draft red herring prospectus and red herring prospectus are powerful documents that state critical information about a company. These help investors in making an informed investment decision, mainly for IPOs. It is important for investors to examine these documents thoroughly and consider all the stated factors. In case a company’s DRHP has incomplete or incorrect information, investors can file a complaint with either SEBI or the IPO’s merchant banker.
FAQs
SEBI, which is the market regulator in India, has made it mandatory for all companies to file a DRHP before approaching the registrar of companies for a public offer. DRHP is reviewed by SEBI and once all the recommended changes are done, the final document is approved by SEBI, the ROC and stock exchanges. This final document is called the Red Herring Prospectus (RHP).
A company’s DRHP is available on various platforms like the company’s website, merchant banker website, stock exchange websites or SEBI website. Various online news portals also carry announcements on the same in multiple languages.
IPO or Initial Public Offering is a process by which privately held companies can make a public offering of their shares and turn into public limited companies. This is mainly done to raise sufficient capital for achieving growth and other business requirements.
A lot size in an IPO is the minimum number of shares of a company that an investor can bid for. Investors can know about the lot size in the IPO application form.
To invest in an IPO, you can download the Fisdom app on your smartphone. This app allows investors access to the stock market through easy trading and Demat account opening, along with various mutual fund investment options.
