Why DRHP (Draft Red Herring Prospectus) is important for the Investors By CS Annu Sharma



Dear Folks

Smiles for all smile

During lock-down in India our economy was paused but not completely since the things are back to pace. Many companies will come out with their Initial Public offer specially the startups. In order to understand a firm fully, one of the most important tools is the Draft Red Herring Prospectus (DRHP). In this write up I am going share with you all that why DRHP is important for the companies coming out with public issue.

The document clarifies the reason why the company wants to raise money from the public, how the money will be used and risks involved in investing in the company. It does not contain details of either price or number of shares being offered or the amount of issue. This means that in case price is not disclosed, the number of shares and the upper and lower price bands are disclosed. On the other hand, an issuer can state the issue size and the number of shares are determined later.

  1. What is a DRHP?

A Draft Red Herring Prospectus, or offer document, is when a company that is planning to raise money from the public provides detailed information about its business operations and financials. This includes details about its promoters, reason for raising money, how the money will be used, risks involved with investing in the company and so on. Investors should bear in mind that it does not provide information about the price or size of the offering.

  1. How do companies prepare a DRHP?

The issuer company approaches a merchant banker to prepare the offer document. Merchant bankers take care of the legal compliance issues as well ensure that prospective investors are aware and kept in the loop of the public issue.

The Securities and Exchange Board of India, or SEBI, has made it mandatory for companies to file a DRHP before going to the Registrar of Companies (ROC’s). SEBI reviews the offer document and checks if adequate disclosures are made. SEBI’s observations or recommendations are given to the merchant banker, who makes the changes and files the final offer document with SEBI, the ROC) and stock exchanges. Again the document is reviewed and observations are given to be implemented. Once that is done, final approval is provided and the document then becomes a RHP (Red Herring Prospectus).

  1. Where can investors find a company’s DRHP?

Investors can access a company’s DRHP on various platforms — the company website, the merchant banker website, stock exchange websites or the SEBI website. Announcements are also made in newspapers in multiple languages as per the rules.

  1. Who Makes the DRHP?

One of the most questionable aspects of the DRHP is its genuineness. While it is drafted by a team of legal counsels who are hired (independently) by the merchant bankers/ underwriters entrusted with the job of selling the securities being offered, they are all (i.e. the legal counsels and the merchant bankers) remunerated by the company. So are the auditors who compute and give opinion on the financial statements. Naturally there is an omnipresent specter of bias in making of the DRHP and on the process of due diligence itself.

 “Making honest disclosures to reveal truth about company and the issue” towards – “Creative writing to make the truth look beautiful”.

  1. How is the DRHP useful to investors?

It is a very powerful tool that provides them with all the necessary information about the company in order to help make an informed decision. Investors must go through the document carefully and can go ahead and do some research on their own about performance of other companies in the space and so on. SEBI reviews the draft document and checks if adequate disclosures are made. It gives its observations to the merchant bankers, who make the required changes and file the final offer document with SEBI, the ROC and stock exchanges.

  1. What can investors do if they notice discrepancies?

If there is any inaccurate or incomplete information in the DRHP, investors can register a complaint either with the merchant banker or SEBI. The role of the merchant banker, in this case, is to take care of the legal compliance issues and ensure that prospective investors are aware and kept in the loop of public issue.

  1. How it named as Prospectus?

An issuer can state the issue size and the number of shares are determined later. An RHP for and FPO can be filed with the ROC without the price band and the issuer, in such a case will notify the floor price or a price band by way of an advertisement one day prior to the opening of the issue. In the case of book-built issues, it is a process of price discovery and the price cannot be determined until the bidding process is completed. Hence, such details are not shown in the Red Herring prospectus filed with ROC in terms of the provisions of the Companies Act. Only on completion of the bidding process, the details of the final price are included in the offer document. The offer document filed thereafter with ROC is called a prospectus.

  1. What about Wrong Disclosures in the Prospectus?

Making untrue statements of facts or omitting to state material facts in the prospectus could lead to penalties ranging from monetary fines to the merchant banker’s license being revoked. Recently however SEBI has started taking actions in this regard. There was a case where, DLF was fined Rs. 85 crores for not disclosing certain material information and facts in its IPO document.

CONCLUDING TIPS:

There are good reasons to pay attention to some sections of the DRHP. In particular you should look at the management section which covers promoters, directors and other key people in the company. Lawyers have little room to pull the wool over your eyes about these aspects. An honest and competent management is one of the most important investment tenets you should be looking for. Similarly, pay close attention to the chapter – Use of Proceeds. This will tell you what the company intends to do with the money they raise.

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