What is Red Herring Prospectus (RHP) in an IPO and Its Importance

Among the various instruments offered for investment in today’s financial arena, the IPO or Initial Public Offering stands out as a means to explore stock investment. A privately-held firm floats an IPO when it wishes to make its stock available to the public, and consequently, be listed on the stock exchange. The company allows investors to subscribe to an IPO and allots shares to investors after subscription. However, before investors decide to subscribe to any particular IPO, they have to study a vital document issued by the IPO-floating company, known as the Red Herring Prospectus. Commonly called the “RHP”, this plays a critical role in an investor’s decision to invest.  

What is a Red Herring Prospectus?

Now, that you know you must study the RHP in detail before investing in an IPO, you may be asking the question, “What is the Red Herring Prospectus?”. Essentially, the RHP is a document that is issued by the company floating an IPO. This document is submitted to particular regulatory bodies like the Securities & Exchange Board of India (SEBI) for the purpose of verification and authentication. An initial document that has relevant company information, the RHP does not include details about the quantity of stock offered through the IPO, or the price of the stock. The words “red herring” are printed in red on the document’s cover page, mentioning a disclaimer that discloses that the information of the RHP is partial and may change at any time until the statement of registration of the IPO is achieved.  

How does a Red Herring Prospectus work? 

The working of an RHP in an IPO is not difficult to understand. The Red Herring Prospectus of any business launching an IPO undergoes several steps before it can be termed conclusive. At the start of the process, the company is required to send a draft of the RHP to the concerned regulatory bodies. Commonly referred to as the “red herring” or “draft red herring prospectus”, this draft acts as an outline or summary that must be verified by regulatory bodies before a final draft (RHP) is issued. Regulatory authorities examine the draft for compliance and other necessary RHP details, checking whether the document meets precise standards of information dissemination.  

When the initial draft is submitted to regulatory bodies, it undergoes thorough verification. Then, the regulatory entity guarantees that all the information meets the criteria of issuing a Red Herring Prospectus to investors and other parties in question. In effect, the original draft, after meeting all approvals, becomes the RHP. Once this process is completed, investors may assess the company’s details through the RHP and make decisions for their further investment.  

Key Benefits of a Red Herring Prospectus 

The RHP is important due to its primary function of serving as a document of accurate information regarding an about-to-be-listed company floating an IPO. As a source of precise information for investors, the RHP is a necessary document to know about future investment in a company. Hence, this document has key advantages, mentioned below:  

View of the Operations of any Business: An RHP gives you a keen insight into the company you are considering for investment through an IPO. This document is especially important to study as a new company, like a start-up, may be launching an IPO. To know more about the workings of the company, its financial data, its position in the industry, and its prospects, you must study the Red Herring Prospectus, which permits you to achieve a comprehensive understanding.  

Insight into the IPO: The Red Herring Prospectus may not provide any specific details about the quantity of shares or the IPO price, but it does offer some clues about what the business wishes to offer the general public.  

Knowledge of a Firm’s Prospects: The RHP gives you a potentially accurate picture of any business’s growth in the industry, sector, or market. Hence, the RHP acts as an indicator of a company’s potential ability to grow in the future.  

Transparent Information: The RHP is a transparent document that reflects all aspects of a company to consider when an investor has to invest. This is vetted by regulators so clarity is the cornerstone of the RHP.  

Measure of Decision-Making: The RHP plays a key role in the investment decision-making process when investors are interested in a certain IPO. Investors may not only gain knowledge of the company in question but also whether the company’s business model and plans align with investors’ financial interests.  

Why the Red Herring Prospectus is Important for Investors 

After reading all about the RHP, you may have gauged why this document is very pertinent for investors who wish to invest in a newly listed company’s stock via an IPO. The RHP contains specific variables about the company in question and investors should watch out for these while studying the RHP:  

Data on Capital 

Knowing about the structure of capital of a business is imperative to assess the company’s financial framework. You should learn about its equity share capital, authorised share capital, paid-up capital, and issued capital. All these factors must be considered before the IPO is launched.  

Financial Information

An RHP in an IPO includes accurate financial data about the company, reflected in audit reports and balance sheets. From this, you get a hang of the company’s historical financial record and its potential for dividend payments.  

Industry/Sector Summary 

Intricate details of company operations represent the industry or sector that it is a part of. The RHP of a business about to go the IPO way gives investors an overview of the sector or industry that the company belongs to, the products and services it manufactures, its competition, trends of performance in the industry, and potential growth.  

IPO Goal and Offer 

The Red Herring Prospectus gives investors information concerning the reasons behind the company launching an IPO.  

Plans, Strategies, and Business Model 

The company’s operations are highlighted in the Red Herring Prospectus, not to mention its business model and any strategies that may be on the table. Product management and marketing plans may be delved into, and this is relevant as the raising of funds through the IPO route may be directly linked to this.  

Promoters and Management 

The section on the company’s promoters gives you clues as to who is promoting the company. Furthermore, related to the people who operate the company, you get a good sense of the company’s current management and their vision for the company.  

Declaration of Dividends 

While this is not mandatory for any company to disclose in the RHP, a company may opt to offer some guidelines on future dividend payouts, helping investors to plan investments better.  

Company Risk

The section to do with risk generally highlights risks related to any company. However, investors must pay close scrutiny to particular risks concerning the business launching the IPO. Such risks could include anything from liabilities like debt or pending legal issues. For a prospective investor, this part of the RHP is specifically important in that it may raise red flags.  

Conclusion

When an IPO is issued, the Red Herring Prospectus is a document that is crucial for investors to get a potentially sound idea about the company floating the IPO. This document assists investors in making informed decisions regarding their investment as it provides relevant information about the company in great detail. The Red Herring Prospectus (RHP) has pertinent details about the company’s management, operations, business model, financial data, and prospects in the long run. If you are looking to subscribe to an upcoming IPO, you must grasp how an RHP works so you can navigate the document to make investment decisions aligned with your financial requirements and goals.