What is DRHP (Draft Red Herring Prospectus)?
For any company seeking to go public, submitting a Draft Red Herring Prospectus represents a pivotal milestone in the Initial Public Offering (IPO) process. This document is submitted to regulators and offers an overview of the company’s operations, finances, management, and possible risks. DRHP offers investors comprehensive insights that determine their interest in an upcoming IPO. Understanding the intricacies of this document is essential for anyone looking to invest in an upcoming IPO.
In this blog, we will discuss the Draft Red Herring Prospectus (DRHP), how it is prepared, its importance and the difference between RHP (Red Herring Prospectus) and DRHP.
What is a Draft Red Herring Prospectus?
A Draft Red Herring Prospectus is a preliminary document submitted to the Securities and Exchange Board of India (SEBI), a regulatory body in India when a company plans to launch an Initial Public Offering (IPO). It offers vital insights into the company’s business operations, financials, risks, and goals for raising capital. It does not specify the number of shares offered or the price, as these details are decided later.
IPO stands for Initial Public Offering. It refers to the process a private company follows when it first sells its shares to the public on the stock exchange. This transforms the company from being privately owned to publicly owned.
Launching an IPO and getting listed on the stock exchange can be a significant event for any company. However, this journey demands meticulous planning, due diligence and execution.
How is a DRHP prepared?
Preparing a DRHP is a lengthy process, starting with the company appointing merchant bankers to determine the IPO details and ensure everything complies with the regulatory needs. The legal advisors ensure that all disclosures and anything else mentioned by the company will not lead to any litigation.
Significant due diligence is performed on the operations, financial statements, assets, liabilities, history of litigation, and dealing with the regulatory framework of the concerned company. Conducting due diligence is vital to ascertain that what is stated in the DRHP stands true for accuracy and comprehensiveness.
This phase consists of assessing the company’s business model, sources of income, market placement, and competition against other players. The company presents its financial statements for the past three years, which are then audited by an independent auditor. This part of the DRHP contains profit and loss statements, balance sheets, cash flow statements, and financial ratios.
An essential element of the DRHP is the risk factors section, which details the various risks that could affect the company’s operations or stock performance. This includes market competition, regulatory challenges, operational uncertainties and external influences. The document also includes an analysis of the industry landscape, trends, growth prospects, and the company’s position.
Legal advisors create documents to ensure the prospectus meets regulations and follows guidelines set by the regulatory authority. This involves preparing disclosures on shareholding patterns, promoter details, the board of directors, and corporate governance structure. The DRHP is usually available for the public on the regulatory authority’s website, allowing investors and analysts to review and analyze new IPOs.
The draft document is subsequently submitted for review to regulatory authorities such as the SEBI in India or the SEC in the United States. Regulatory authorities verify the details mentioned in the DRHP and may request changes or clarifications. The company changes the document based on the feedback from the regulatory body.
Once the regulatory body approves the DRHP, it is finalized into an RHP (Red Herring Prospectus). The RHP document includes information about the price range, issue size, etc.
Benefits and Importance of a Draft Red Herring Prospectus
The benefits of a DRHP are:
- Helps in Investment Decisions: The DRHP offers a detailed look at the company’s operations, finances, and risks, helping investors evaluate its financial health and make informed investment decisions.
- Compliance with Regulatory Standards: Regulatory bodies like the SEBI in India require companies to submit a DRHP document to ensure that they meet disclosure requirements and that the IPO process stays transparent. It allows regulators to review company disclosures, reduce fraud risk and protect investors.
- Establishing Credibility and Market Confidence: A well-prepared DRHP enhances the company’s credibility by demonstrating its commitment to transparency and regulatory compliance. This boosts investor confidence, attracting more interest in the IPO.
- Opportunity to Showcase the Company’s Potential: The DRHP offers companies a chance to showcase their growth potential, strengths, competitive advantages, and unique position within the industry. It allows them to present a compelling narrative about their future prospects.
- Gauging Investor Interest and Feedback: The DRHP is usually posted on the regulatory authority’s website for the public. This lets potential investors, analysts and market participants review the document and share the comments and concerns.
- Legal Protection and Reduced Liability: By providing clear and complete information in the DRHP, the company reduces the risk of lawsuits and regulatory penalties for non-disclosure of important information. This protects the company and shows that it is acting in good faith by keeping the investors informed.
DRHP Vs. RHP
| Criteria | DRHP | RHP |
|---|---|---|
| Definition | The DRHP is a document submitted to the SEBI by the company, which marks the first step in the IPO process. | The RHP is the final document issued after the SEBI approves the DRHP. |
| Timing | DRHP is submitted to regulators for review and approval. | After incorporating the feedback of the SEBI, the DRHP is approved and finalized into an RHP. |
| Purpose | DRHP is prepared to seek SEBI approval and public feedback. | RHP incorporates all the changes recommended by the regulator and is released to announce IPO dates. |
| Content | The DRHP includes most of the details needed, such as the business overview, financials, risks, strengths etc. | The RHP has the complete information, including the price range, total shares being offered, and the IPO dates. |
Conclusion
Submitting DRHP to the regulator is an important event for companies and investors during the IPO process. For businesses, it guarantees transparency and adherence to regulations, allowing them to effectively showcase their strengths and future potential to investors. The DRHP helps companies maintain accountability and provides investors with tools to evaluate whether to invest in the IPO. The document increases market transparency and builds trust between companies and investors, paving the way for a successful IPO and long-term growth.
Frequently Asked Questions (FAQs)
Why is DRHP important?
A Draft Red Herring Prospectus (DRHP) is important because it helps investors make informed investment decisions and ensures regulatory compliance for companies going public.
Is a DRHP the same as a RHP?
No, the DRHP is a preliminary document. After regulatory review and finalization, it becomes RHP with full IPO details.
Who reviews the DRHP?
Regulatory authorities, such as SEBI in India, review the DRHP to ensure compliance.
What is the validity of DRHP?
A DRHP is valid for 12 months from the date of receiving the SEBI’s Observation letter. SEBI reviews and issues an observation report within 30 days of submission of DRHP.
How is a DRHP different from a shelf prospectus?
A DRHP is a document related to IPOs, while a shelf prospectus is a document when a company wants to issue bonds.
