While investing in the stock market, you may have come across various IPOs in the market. Choosing the right company to invest in, among numerous IPOs, can be overwhelming. In this case, a draft red herring prospectus (DRHP) can serve as a valuable tool to understand IPOs.


Read on to learn more about DRHP, its benefits, components and more.

What is a DRHP?

A draft red herring prospectus, is a preliminary document submitted to the Securities and Exchange Board of India (SEBI), introducing a new product or new business to investors. This document outlines the framework for the early stages of an Initial Public Offering (IPO).
 

Bear in mind that to participate in an IPO, investors must own a Demat account. Moreover, through the IPO process, private companies can raise the required capital. 

 

After submission, SEBI reviews the document and suggests some changes. The final version of the document, after the suggested amendments, gets approved by SEBI, the stock exchanges and the ROC. Then, the draft red herring prospectus (DRHP) becomes a red herring prospectus (RHP).

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Features of a DRHP

Check out some of the good-to-know features of a DRHP

  • Introduces potential investors to new products and businesses

  • Elevates the visibility and credibility of the issuing company in the market

  • Communicates the issuing company’s offerings, business model and risks

  • Undergoes scrutiny from regulatory bodies like SEBI for accuracy and verification

  • Ensures alignment with legal compliance as required by the regulating bodies

Components of DRHP

Here are the various components of a draft red herring prospectus (DRHP).

Use of IPO Proceeds

  • This segment communicates the issuing company's purpose for utilising the capital generated through the IPO process.

  • Different companies have different financial needs and plans on how they wish to utilise the funds. 

  • Companies might use the capital for repaying their debt, meeting their working capital requirements or purchasing a new warehouse.

  • Through a DRHP, you get to examine the company's capital arrangement. This can reveal significant investments of the company, providing insights into the finances of the company.

Information About the Company

  • A draft red herring prospectus provides essential information about the issuing company, including the company's fundamental activities and operations.

  • If you wish to invest in the company, you need to pay attention to this section since it signifies how your money is getting invested in the company.

Details About the Industry

  • Essential details regarding the industry or sector it operates under, as well as the company’s competitive stance.

  • This part of the DRHP encompasses data about: 

    1. The industry’s performance trends

    2. Demand and supply dynamics

    3. Economic factors

    4. Potential growth prospects 

Financial Information

  • A DRHP also provides you with the necessary financial information about the issuing company, including the financial statements and audit reports.

  • It is imperative to examine and evaluate the financial standing of the company to get a clear picture of the company's potential for future growth. 

  • A DRHP also provides you with information regarding the potential dividends that you stand the chance of earning through the IPO.

  • As an investor, this information helps assess the security and profitability of your investment.

Management

  • The company’s management has a key part in shaping the business and its future growth prospects. This is because they handle various essential components of the company, including expansion strategies, decision-making, marketing, and potential growth opportunities. 

  • This section of the DRHP provides information on the core leaders behind managing the company. Understanding the leaders at the helm is key, as you are investing in them as well. 

 

The draft red herring prospectus helps you understand the potential risks associated with the company and the industry. In case you are planning to invest in the company, knowing about these risks is essential. These do influence the company's ongoing operations and future growth prospects. 

 

These potential risks may include unsolved legal matters that the company is under or any other hazards that may harm the business. 

 

As it is evident, a draft red herring prospectus (DRHP) encompasses all the essential information that you need to know about an offering. Remember, the stock market is associated with certain risks and therefore, in-depth analysis is essential. 

 

Apart from the DRHP, ensure you research about the company's past performance, stockholders and other information before making financial decisions.

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FAQs About the DRHP

What is the difference between a draft red herring prospectus and a red herring prospectus?

A draft red herring prospectus (DRHP) is a preliminary document that is submitted for regulatory review before a public offering. On the other hand, the red herring prospectus (RHP) is the final prospectus with changes after regulatory approval.

Is it compulsory to issue a red herring prospectus?

Yes, it is compulsory for companies intending to go public through an IPO to provide a red herring prospectus (RHP). This is because an RHP is an essential document containing details regarding the company and the IPO.

To whom is a draft red herring prospectus issued?

A draft red herring prospectus (DRHP) is issued for potential investors, introducing them to an IPO of a company.

What is the meaning of the red herring fallacy?

A red herring fallacy occurs when a red herring prospectus contains irrelevant details to enhance the appeal of the IPO or to undermine the competitors. SEBI regulations mandate accuracy in the prospectus to maintain the confidence of investors.

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