What is a Draft Red Herring Prospectus?
In the world of investment and capital markets, transparency and information are key. Investors need all the relevant data to make educated decisions, and companies looking to raise funds through public offerings are obligated to provide this information. One crucial document in this process is the Draft Red Herring Prospectus (DRHP), which serves as a preliminary registration statement before a company goes public. In this article, we’ll delve into what a Draft Red Herring Prospectus is, its components, its importance, and how both companies and investors can make use of it.
Key Highlights
- A Draft Red Herring Prospectus (DRHP) is a preliminary document submitted to SEBI before launching an IPO.
- It includes essential details about the company, excluding the final price band and the number of shares.
- The DRHP is open for public review, allowing investors to assess the company’s potential before the final offer is made.
- The DRHP serves as a basis for investor feedback, which helps in finalising the IPO details such as pricing and share allocation.
Table of Contents
Draft Red Herring Prospectus Meaning
The draft red herring prospectus is the preliminary prospectus presented by an issuing company before an IPO to SEBI. Unlike the final prospectus, it cannot include the issue price and quantum of issue, which, again, are finalised per investors’ feedback and market conditions. This document discloses the business model, financial performance, and management together with associated risks in detail so that the potential investor can make an informed decision regarding investment in the firm. The DRHP, once SEBI has reviewed and the changes have been incorporated, forms the basis for the final Red Herring Prospectus, including the full details of the IPO.
Why is the Draft Red Herring Prospectus (DRHP) Important for investors?
DRHP is the most important document for IPO investors. One of the primary reasons has to do with the amount of information it reveals about a company. One gets all the information necessary to make an informed investment decision by simply going through this document.
That said, because an average DRHP can run anywhere between 300 to 500 pages in length, reading through the document is not practical. However, what you can do instead is go through the most important sections thoroughly.
The management of the company, experience, and skill set are the things that you must look at over and above while analysing the company coming out with an IPO. Checking the industry overview also becomes important as it may reveal a lot of information about the environment in which the company operates.
Where can Investors Find a Company’s DRHP?
DRHP of a company can be found on various platforms such as the merchant banker website, the company’s official website, stock exchange websites or the official SEBI website. Online news portals and newspapers also make announcements in multiple languages.
Example of a Draft Red Herring Prospectus (DRHP)
Company Name: XYZ Ltd.
Industry: Software Development and IT Consulting
IPO Size: ₹500 crore
Offer Type: Fresh Issue and Offer for Sale
Promoters: John Doe and Jane Smith
Lead Managers: ABC Securities, DEF Capital
Business Overview:
XYZ Ltd. is a mid-sized software development and IT consulting firm that has been operating for over a decade. The company specialises in providing cloud-based solutions to businesses across various sectors, primarily serving clients in North America and Europe. For FY 2023, XYZ Ltd. reported a revenue of ₹850 crore, a net profit of ₹120 crore, and an EBITDA margin of 20%. The company maintains a healthy debt-to-equity ratio of 0.4x, reflecting its stable financial position.
XYZ Ltd. plans to raise ₹500 crore through its IPO, with ₹300 crore coming from a fresh issue of shares and ₹200 crore from an offer for sale by existing shareholders. The funds will be utilised to expand the company’s global operations, invest in research and development, repay a portion of its outstanding debt, and meet general corporate expenses. This capital infusion is expected to strengthen XYZ Ltd.’s market position and support its long-term growth strategy.
The DRHP also highlights potential risks, such as the company’s reliance on a few key clients, exposure to foreign exchange fluctuations, and intense competition within the software development industry. This information allows investors to evaluate the associated risks before committing to the IPO. Once SEBI reviews the DRHP and any necessary adjustments are made, the final Red Herring Prospectus (RHP) will be issued, including the IPO’s price band and share allocation details.
Difference Between RHP & DRHP
Understanding the differences between the Red Herring Prospectus (RHP) and the Draft Red Herring Prospectus (DRHP) is crucial for investors looking to participate in an Initial Public Offering (IPO). The RHP and DRHP serve distinct purposes in the IPO process, with each document providing specific details at different stages of the offering. Below is a comparison between the two:
| Aspects | Red Herring Prospectus (RHP) | Draft Red Herring Prospectus (DRHP) |
| Definition | It’s a document that is filed to the regulatory body. Everything about the impending IPOs is included, except for the price and quantity of shares issued. | Before an IPO, the DRHP preliminary version is made public. It includes all pertinent information, except the size and price of the final issue. |
| Timing | It is released after receiving regulatory approval | DRHP is submitted to the regulators for review and approval before launching IPO |
| Content | RHP contains information relevant to the investors for investing in the company, such as the company’s operations, financials, promoters, objectives of the issue, and other details that is relevant to potential investors | DRHP contains information required in the RHP, except the final issue price and size |
| Pricing and issue size | It includes information about the IPO price and the number of shares | DRHP does not contain the final IPO price. Price is decided later on the basis of market evaluation. |
| Public offering size | RHP indicates total offering size: number of shares and price | DRHP states the approximate size |
| Regulatory approval and filing process | RHP is released after receiving final approval from the regulators | The DRHP is modified as a result of the DRHP being submitted for regulatory evaluation and feedback. |
Benefits and Importance of a Draft Red Herring Prospectus
DRHP allows the potential investors to study details of the IPO and get a feel of the IPO before actually deciding upon investing. It will help in assessing the growth potential of the company, competitive edge, and financial governance.
The companies also use DRHP as a marketing tool to evaluate the potential interest that the market may have for their company. By releasing a DRHP, companies can test their business model and the viability of the proposal.
One such avenue for companies to understand market interest through a DRHP saves them from the complicated, time-consuming, and costly process of bringing out the final RHP prospectus with full legal compliance.
Although DRHP is a preliminary document, it contains sufficient disclosures for making the investment or non-investment decisions of interested investors in the IPO. Later on, based on the information contained in the DRHP, the investor will be in a position to see their investment grow or measure the risks and hazards associated with investing in the company.
Conclusion
The draft red herring prospectus acts as a strong tool carrying all the critical information about a company, thereby helping any investor to make an informed decision. The document shall have to be examined thoroughly, and all the factors should be weighed. It will also help to research other companies and IPOs past performance in the same domain to enable the investor to make comparisons and arrive at a well-researched conclusion. You can write a complaint to the in-charge merchant banker or SEBI in case incomplete or incorrect information appears in the DRHP.
FAQ’s on DRHP
The company planning to go public prepares the DRHP after consulting with its SEBI-registered merchant bankers.
These are the essential details that one should look for in a DRHP.
- Business specifics
- The company's finances
- Factors at risk
- Utilisation of the IPO proceeds
- An overview of the industry
- Details of management
After the date of receipt of the observation letter, the DRHP is valid for a full year.
Depending on the case's complexity and the level of disclosure in the DRHP, the clearance process may take a few weeks to several months. Additionally, SEBI may request more details or explanations, which could cause the process to take longer. It must submit its observations by SEBI guidelines within 30 working days of obtaining the DRHP. This time frame, though, can be extended if SEBI has any questions or needs more data.