NFO and IPO are among the most common ways for companies to raise funds. It is easy to find everything you need to know about a company that has its shares listed on the stock exchanges. All you have to do is open your stock broking app or platform, search the company, and you have all the information you need.
But what about a company that is offering its shares to the public for the first time? How do you know whether the company is worth investing in, or should you avoid having its shares in your portfolio?
For companies coming out with an IPO, a Draft Red Herring Prospectus is one document you should look at.
What is Draft Red Herring Prospectus?
When a company launches an Initial Public Offering (IPO), it plans to raise funds from the general public. However, the general public must know everything about the company to decide whether to apply to the IPO or avoid the issue. Hence, the Securities and Exchange Board of India (SEBI) has mandated that every company that wants to launch an IPO present a document containing details about the company and the potential IPO issue.
A Draft Red Herring Prospectus (DRHP) is a detailed document filed by a company to help investors properly understand the company, generate interest in the upcoming IPO, and increase the IPO allotment status level. Companies also use this document to introduce a new product or business to potential investors. As the name suggests, DRHP is not the final document but a draft to roughly outline the formal prospectus, called the Red Herring Prospectus, which is filed after SEBI approves the IPO issue.
What are the components of a Draft Red Herring Prospectus?
Here are the components of a Draft Red Herring Prospectus (DRHP) and the information you will get about the company:
- Object for raising funds
The DRHP will contain the reason for which the company is planning an IPO and trying to raise funds from the public. The company may raise funds for business expansion, debt repayment, working capital requirements, launching a new product, or buying new assets. - Business description|
This section provides information about the nature of the business operations and how the company conducts its business. You can understand the industry in which the business operates and the target customers. - Financial details
The financial details section is one of the most important sections as it details the company's financial health. The section includes all the company's financial reports, which you can analyse to understand the company’s historical performance, profitability, and future growth potential. - Management
The company management is critical in running the business and ensuring its profitability in the future. The promoters, directors, and executives are the main decision-makers for the company, making it important to know the details about these individuals. This section also provides information about any legal cases pending against the company’s directors, promotors, or executives. - Industry overview
While analysing a company and its IPO issue, it is important to understand the industry it operates in and how it is currently performing. This section provides information about the industry's performance, allowing you to decide whether investing in a company operating in this industry is justified. - Risk factors
Operating a business always comes with risks, which the company knows extensively. This section provides information about all the risk factors faced by the company because of external factors such as demand and supply or from competitors. Investors can assess the factors and decide whether they wish to subscribe to the IPO.
Why should a company file a Draft Red Herring Prospectus?
SEBI mandates the filing of DRHP if a company wants to launch an IPO to raise funds from the general public by listing the shares on the stock exchanges. Hence, companies must file a DRHP with SEBI. Once the company files the DRHP, SEBI reviews the document and makes necessary suggestions until it is approved. Once approved by SEBI and the Registrar of Company (ROC), the stock exchanges convert the DRHP to the final RHP.
Where can you find the DRHP of a company?
Now that you know what is DRHP, the next step is to know where you can find and read it. The best way to find a company's DRHP is by visiting SEBI's website. Every DRHP is listed on SEBI's website for public viewing. Furthermore, you can find a company’s DRHP on the merchant banker’s website or the stock exchanges' websites, such as NSE and BSE.
Why is a Draft Red Herring Prospectus important to investors?
The Draft Red Herring Prospectus is important for investors if they want to analyse a company to decide whether investing in its IPO would be profitable. The DRHP provides information about the company, its operations, industry, risk factors, and management to allow investors to research every aspect of the company. Afterwards, investors can make informed decisions about subscribing to the company’s IPO.
How is a DRHP different from an RHP?
The DRHP is a draft that companies must file with the SEBI. It gives a rough outline of the information that needs to be provided to investors. Companies file the DRHP to ensure that SEBI points out all the mistakes before they launch the IPO, and the company can rectify the mistakes or add suggested changes. RHP, on the other hand, is the rectified version of the DRHP and is the final document targeted toward investors who want to know everything about the company and the upcoming IPO.
Final words
The DRHP is a detailed document that averages 300-500 words and aims to provide every possible information about the company to the investors. However, as it is almost impossible for the average investor to go through every section of the DRHP, you can simply go through the main components mentioned above and decide whether or not to apply to a company’s IPO.
