Introduction:

Initial Public Offerings (IPOs) are well-known for attracting the interest of investors and creating a big buzz in the market. However, 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 Draft Red Herring Prospectus (DRHP) can help you assess their potential and understand what they are offering.

1. 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. Many are unsure about the DRHP’s meaning, but 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.

What it does not include is details of the number or price of shares being offered, or the amount of issue. If the price is undisclosed, the number of shares and lower and upper price bands are declared. Alternatively, the issuer can announce the issue size and the number of shares can be specified later on. The price can only be determined after the bidding process is over. For book-built issues, details like these are not mentioned in the red herring prospectus filed with the Registrar of Companies  (ROC) with regards to the provisions of the Companies Act.

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 Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE). Further observations and changes at this stage can be implemented after reviewing the final document.

2. How do companies prepare a DRHP?

The company seeking to float an IPO enlists a merchant banker to prepare the DRHP.

The issuer company enlists the services of a merchant banker to prepare the document. Here, the merchant banker attends to the legal compliance issues and ensures that prospective investors are all kept in the loop when it comes to public issues. The salient component of a draft red herring prospectus are as follows:

  • Business Description:

This section describes the company’s core operations and how business is conducted. Prospective investors should make note of this segment as it indicates how your investment will be put to use in the business operations, and as a shareholder, this is where you will hold ownership.

  • Financial information:

One of the most important sections is where the company’s audit reports, as well as financial statements, are shown. The financial statement gives an idea of future dividends on the basis of the profits that are disclosed. As an investor, this information helps you assess the profitability and safety of your future investment.

  • Risk Factors:

Here the company lists the potential risks that may impact their business; while some are general risks, others need to be examined carefully. For example, pending legal cases are a factor that makes an IPO a very risky and therefore unviable investment. Potential investors should read this section closely to identify such risks.

  • Use of Proceeds:

This section clarifies the company’s intentions regarding the capital raised through the IPO. The plan may include using the proceeds to pay off debts, acquire new assets or meet their working capital needs. You can also look at the company’s capital structure to see if any big private shareholders have made investments.

  • Industry overview:

A draft red herring prospectus includes vital information on the position of a company in relation to competitors in the same industry. This section carries data on performance trends of the industry the company deals in, and this is where various economic variables, demand and supply mechanisms and future prospects come into the picture.

  • Management:

The management of a company plays a crucial role in determining their business prospects.After all, the management is in charge of strategizing on matters like expansions, renovations, marketing and overall growth. This section mentions the names, designations, and qualifications of key management personnel, promoters and directors. It may also include risk factors like pending litigations or cases against any of them, so it’s necessary to read this section thoroughly.

3. Why do companies need to file a DRHP?

Sebi has made it compulsory for all companies to file a DRHP prior to approaching the ROC. The offer document is reviewed by Sebi, and after all the recommended changes are made and the final document is reviewed and approved by Sebi, the ROC and stock exchanges, the document finally becomes a Red Herring Prospectus (RHP).

4. Where can investors find a company’s DRHP?

A company’s DRHP can be accessed on various platforms such as the merchant banker website, the company’s official website, stock exchange websites or the official Sebi website. Additionally, online news portals, as well as newspapers, also make announcements in multiple languages.

Conclusion:

The draft red herring prospectus is a powerful instrument that carries all the critical information about a company, thus helping investors make an informed decision.  The document must be examined thoroughly and all the factors should be weighed in. Moreover, doing some additional research on the performance of other companies and IPOs in the same domain can help you, as an investor, compare options and come to a well-researched conclusion.  In case the DRHP carries any incomplete or incorrect information, a complaint can be registered with either the merchant banker in charge or Sebi.