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What is Draft Red Herring Prospectus?

A Draft Red Herring Prospectus (DRHP) is an ‘offer document’ or ‘preliminary registration document’ that a company files with the Securities and Exchange Board of India (SEBI). The document introduces a new business or product to investors. The DRHP serves as a framework for the IPO’s early stages.

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The prospectus should convey the vision to the target audience as it introduces the products and business. This is not a final document for an investor, but it shows the value and gives them enough information to analyze and make an investment decision. Furthermore, it also includes the current business status and investment risks.

It’s generated at the start of an IPO as an outline of the formal prospectus. The purpose is to give potential investors and company executives a preview of the formal prospectus, which is prepared after the DRHP. It includes corporate history, financing details, and market research. It outlines how much funding will be needed for each investment stage and highlights the company’s favourable aspects.

A DRHP is a preliminary offering memorandum designed to promote interest in securities before an SEC prospectus is filed. Thus, it informs investors about an issuer and its securities, secures commitments, and solicits feedback.

Recommended Read: What is Red Herring Prospectus?

Things to Look for in a Draft Red Herring Prospectus DRHP

DRHP is a comprehensive document that is filed with SEBI and provides key information about the company to prospective investors. Following are the things to look for in a Draft Red Herring Prospectus:

Utilisation of IPO Proceeds

Companies apply for an IPO for a variety of reasons. This section mainly addresses the following questions:

  • Have any significant private investors invested in the business?
  • What is the company’s current capital structure?
  • Why does the company aim to obtain funds via an initial public offering?
  • How does the corporation intend to lower its existing debt?
  • Does the company intend to acquire new assets?
  • How will it satisfy its working capital requirements?

About the Business

This section describes the following:

  • Basic operations
  • The manner in which the firm conducts business

This part highlights how the company intends to utilize the funds raised through an IPO and conducts its core business operations. This is vital information, as investors must have a clear idea of how the money is used.

Financial Information

Considered to be one of the most crucial elements of a DRHP, the financial information segment includes audit reports and financial statements.

Every investor must review and analyse the financial statements to determine the company’s future growth prospects. Furthermore, it is necessary to understand the dividend prospects.

Read our article related to What is Financial Planning?

Risks

The DRHP contains details of all the potential risks that could have an effect on the present business and operations of the company. The title of this section is “Risk Factors.” Some of the risks under the section may be standard for the business. However, investors must critically examine other factors to know what they may get exposure to.

For instance, if you discover that the company has numerous pending legal proceedings. Thus, in these situations, it is prudent to avoid investing in the IPO. Investors must be able to read between the lines in order to identify the true threats that may impact the company’s growth potential in the future.

You can explore our article on 5 Tips for Investing in IPO

Industry Overview

A draft red herring prospectus contains information regarding the company’s status in relation to its competitors. It also contains information regarding specific industry trends. In addition to the demand and supply functions that help gauge the company’s future prospects. Thus, investors seeking to invest in an IPO should evaluate the various commercial and economic variables at play.

Management

The individuals responsible for the day-to-day operations of an organization have a significant impact on its future prospects. Therefore, management is accountable for:

  • Strategic decision making
  • Future growth prospects
  • Expansion strategies
  • Marketing efforts, etc.

Here, you can get a view of information about the company’s directors, promoters, and other key management personnel. In addition to the names, you can know their qualifications and titles. Also, the section contains details regarding any criminal cases or pending litigations against the company’s management.

Difference Between Red Herring Prospectus and Draft Red Herring Prospectus

Following are the key differences between Red Herring Prospectus and Draft Red Herring Prospectus:

Basis of DifferenceDRHPRHP
MeaningA DRHP is an early form of an RHP. It is generated before the full prospectus is finalized.A Red Herring Prospectus is an offer document that is prepared and filed with the SEBI at the time of a company’s initial public offering of its shares.
ContentIt includes high-level information on the company’s business plan, financial standing, and significant offerings.A red herring prospectus is a comprehensive document comprising all the information about the company that an investor must know before investing.
Alternative useIt is only disclosed to the public prior to an IPO.A corporation that is already public and wishes to provide an overview of its activities to potential investors may utilize a red herring prospectus.
Review and approvalInternal company accountants can analyze DRHP prior to its release to the public. However, the company cannot file it with SEBI as it is a draft.Certified public accountants must evaluate the RHP for securities regulators to approve it.

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