March 31, 2022 05:10 PM
When a company plans to raise money (for example: float an IPO) from the public by selling its shares to investors, it files and submits a Draft Red Herring Prospectus (DRHP), also known as ‘offer document’ or ‘preliminary registration document’, with the market regulator SEBI(Securities and Exchange Board of India).
The DRHP document includes information about the company’s business operations, promoters, financials, its standing in the industry it deals in and listed or unlisted peers.
The DRHP document clarifies the reason why the company wants to raise money from the public, how the money will be used and risks involved in investing in the company.
It does not contain details of either price or number of shares being offered or the amount of issue. This means that in case price is not disclosed, the number of shares and the upper and lower price bands are disclosed. On the other hand, an issuer can state the issue size and the number of shares is determined later.
The price cannot be determined until the bidding process is completed. In case of book-built issues, such details are not shown in the red herring prospectus filed with ROC in terms of the provisions of the Companies Act.
The role of the merchant banker, in this case, is to take care of the legal compliance issues and ensure that prospective investors are aware and kept in the loop of public issue.
DRHP, a legal preliminary prospectus, serves as a crucial communication link between the company and its investors and stakeholders.
SEBI reviews the draft document and checks if adequate disclosures are made. It gives its observations to the merchant bankers, who make the required changes and file the final offer document with SEBI, the ROC and stock exchanges.
The final document is reviewed, and observations if made, are to be implemented.
Through DRHP, the issuer firm allows potential investors to make an informed decision and analyse its financials, issuance objectives, business operations, promoter holding, market valuation, and other important information.
The DRHP document explains why the firm seeks to raise funds from the public, how the money will be utilised (use of proceeds) and the risks involved. However, it does not include the amount of issue and details of the price or number of shares being offered.
The DRHP of a company is available on the official websites of the issuing company, SEBI, merchant bankers and stock exchanges.
As an investor, here are a few things to look at in a Draft Red Herring Prospectus (DRHP):
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 utilised 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.
This is one of the most important segments and contains the company’s audit reports and financial statements in DRHP. 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.
Companies lists out the potential risks that could impact their business and operations under a section titled ‘Risk Factors’ are things to look at in a Draft Red Herring Prospectus (DRHP). While many are routinely listed risks, some risks need to be scrutinized. For instance, if you find that the company has a number of pending legal cases, it may be a good idea to avoid the IPO. 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.
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.
A DRHP 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 analyse the various business and economic variables at play, the demand and supply mechanism and the future prospects.
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 in DRHP.
It may also have information about any criminal cases or that of financial delinquency or pending litigations against these people. It is important to check this section because all these can be a risk factor.