What is a Red Herring Prospectus?A red herring prospectus is a document filed by a company who wishes to raise money by issuing an IPO. This document provides all the useful information to the investors starting from the business model of the company to objective of raising funds. Now you must be thinking that, why should you read a red herring prospectus? Well, we all could relate to this. Whenever we buy anything be it a new phone or a new bike, even if it’s a newly launched or extremely hyped you would take a step forward to research about the product. You will compare its features, prices and then decide if it’s worth buying or not. Similarly, before applying for any upcoming IPO, you must research about the company by reading the red herring prospectus or else you might fall into a trap and end up investing in the wrong IPO. Download red herring prospectus of some of the most popular recent IPO’s by clicking on the links below.
Process of Issuing a Red Herring ProspectusFirstly, a company who wants to raise funds from an IPO needs to hire an investment bank which also acts as an underwriter. The underwriter initially prepares a draft red herring prospectus (DRHP). It is submitted to the Securities and Exchange Board of India (SEBI). Once the DRHP is approved by SEBI, the red herring prospectus is prepared. It ranges between 400 to 500 pages and contains all the information about the upcoming IPO like:
- Company’s business operations
- Financial statements
- Promoter holding
- Company’s objective behind raising funds
- Risks of investing and a lot more.
Importance of Red Herring Prospectus to InvestorsDuring an upcoming IPO, there is a lot of talk about how good the company is and why one should invest in it. Rather than listening to others’ opinions, you must do your own research. But, reading the entire red herring prospectus is indeed a tedious task. To help you out, we have shortlisted five important sections of the red herring prospectus. These sections will help you analyse the company better. You will also be able to recognize the pros and find possible red flags in a company if any.
Five Important Elements to Analyse in a Red Herring Prospectus
1. About the Company SectionBefore buying any product or service you often go through each detail. Similarly, before investing in any upcoming IPO it is important to know about the company. For this, you can simply visit about the company section of a red herring prospectus. In this section, you will get all the details regarding the company like:
- The business model of the company:
- Industry structure and market opportunities:
- Their remuneration and shareholding pattern.
- Lawsuits and frauds they were involved in (if any).
- The managements’ criminal records (if any).
- Dividend policy of the company:
2. Financial Information SectionFinancial information is one of the most important aspects to understand a company. This section contains audited reports of the last five years. It includes:
- Assets and Liabilities
- Profit and Loss
- Cash Flows
- Statement of changes in equity
- Intangible assets
- Related party transactions
- Capitalisation statement
- Income statement
- Various financial ratios such as adjusted EBITDA, cash flows, etc.
3. Objects of the OfferBefore you invest your hard-earned money, you must check what the company plans to do with the raised funds. If the funds are being raised with the motive of future expansion, then the IPO can be considered worth investing as eventually the company’s revenues would increase and you will make good return on your investment. However, if the company is raising funds to repay debt, then investing in the IPO may not be the best investment decision. For example, Zomato’s objective to come up with an IPO was to fund its day to day operations and expand their business. Whereas, if we take a look at objects of the offer of Macrotech developers Ltd. (Lodha Group), their objective to raise funds was to repay its debt to a great extent. Hence, checking the objects of the offer is very essential before investing. Objects of Offer of Zomato Ltd. Objects of Offer of Macrotech Developers Ltd.
4. Quantitative and Qualitative Disclosures about RisksRisk is a part of every business hence, the company lists down all the possible risks it could face in the future. This includes market risks, interest rate risk, foreign currency risk, credit risk and competitor risk. As an investor, you must identify the real risks that could pose a threat to the company’s future growth.
5. Legal and Other InformationIn this section, you will find all the unsettled lawsuits filed against the company or promoters. Remember, a company which has critical lawsuits is not an attractive investment option. Now, even though you check these five things before investing in an IPO. But, let me give you a bonus tip which you must check post issue. Bonus point: Promoter’s Holdings post listing of share on the exchanges. Apart from the above, you need to check if the promoters are diluting their stake post issue. Partial reduction in the promoter’s holding is normal. But one should keep a close watch on whether the promoter is reducing the stake substantially. Nobody likes to exit a company when it has the potential to reach new heights. But if you find that the promoters are diluting their stake, it can be a red flag. It means they no longer have faith in the company. It is best to avoid investing in such a company. Recommended watch: Five most important things you must check in a red herring prospectus Where Can One Find a Red Herring Prospectus? Investors can access a company’s red herring prospectus on various platforms. SEBIs website Step 1: Visit the official SEBI website: https://www.sebi.gov.in/ Step 2: Go to the filings page and click on public issues. There you will find DRHPs and offer documents of upcoming IPOs. Or you can also download the red herring prospectus from the stock exchange websites.
- To download it from the National Stock Exchange (NSE) website – Click here
- To download it from the Bombay Stock Exchange (BSE) website – Click here