Red Herring Prospectus

A Red Herring Prospectus (RHP) is a preliminary document submitted by a company intending to raise funds through a public issue of securities, such as an Initial Public Offering (IPO) or Follow-on Public Offer (FPO). It contains important information about the company’s business operations, financial statements, promoters, management, and risk factors, but does not include the final price of the securities or the number of shares being offered. The name “red herring” comes from the red-coloured disclaimer printed on the cover page, indicating that the document is not the final prospectus.
The RHP serves as a disclosure document under securities regulations, designed to provide potential investors with essential information to make informed investment decisions.

Meaning and Definition

According to Section 32 of the Companies Act, 2013 (India):

A Red Herring Prospectus means a prospectus which does not include complete particulars of the quantum or price of the securities being offered.

It is filed with the Securities and Exchange Board of India (SEBI) before the public issue of shares and provides a detailed description of the company’s financial health, objectives of the issue, and potential risks. Once the price and size of the issue are finalised, the RHP is updated to become the final prospectus, which is then filed with the Registrar of Companies (ROC).

Purpose of a Red Herring Prospectus

The primary purpose of issuing an RHP is to:

• Provide investors with preliminary but comprehensive information about the company and its securities.
• Gauge investor interest and facilitate the book-building process, where bids are collected at various price levels.
• Ensure transparency in the public issue process, helping investors evaluate the risks and rewards of investing in the company.
• Fulfil regulatory disclosure requirements under SEBI and the Companies Act.

Key Features of a Red Herring Prospectus

1. Preliminary Nature: It is not the final offer document; the final price and number of shares are decided later.
2. Regulatory Requirement: Mandatory for companies opting for the book-building method of public issue.
3. Comprehensive Information: Includes details about promoters, management, financials, risk factors, and legal proceedings.
4. Investor Guidance: Helps potential investors make informed bidding decisions during the price discovery phase.
5. No Offer to Sell: The RHP does not constitute an offer to sell; it only provides information for potential investment.
6. Filed with SEBI: The RHP must be approved by SEBI before it is shared with the public.

Contents of a Red Herring Prospectus

The RHP includes almost all the information found in the final prospectus except the issue price and quantity of shares. Major contents typically include:

• Company Overview: History, objectives, business model, products, and services.
• Promoters and Management: Details about promoters, directors, and key managerial personnel.
• Financial Information: Audited financial statements, performance analysis, and capital structure.
• Purpose of the Issue: How the company plans to utilise the proceeds (e.g., expansion, debt repayment, acquisitions).
• Risk Factors: Disclosure of internal and external risks that could affect operations and profitability.
• Legal Proceedings: Pending litigations or regulatory issues.
• Industry Overview: Market potential, competition, and economic environment.
• Book-Building Process Details: Information on the bidding period, price band, and allocation procedure.
• Underwriters and Lead Managers: Details of the merchant bankers managing the issue.

The cover page carries a red-coloured disclaimer, typically stating:

“The information in this document is subject to completion or amendment. This document does not constitute an offer to sell or the solicitation of an offer to buy securities.”

Procedure for Issuing a Red Herring Prospectus in India

The process of issuing an RHP under Indian law involves several stages:

1. Board Resolution: The company’s board approves the decision to raise capital via a public issue.
2. Appointment of Intermediaries: Merchant bankers, legal advisors, and auditors are appointed to manage the issue.
3. Preparation of Draft RHP (DRHP): A draft version of the Red Herring Prospectus is prepared and submitted to SEBI for review.
4. SEBI Review: SEBI examines the DRHP to ensure compliance with disclosure norms and may suggest modifications.
5. Filing of RHP: After SEBI approval, the company files the RHP with the Registrar of Companies (ROC).
6. Marketing and Book Building: The RHP is made available to the public, and bids are collected within a specified price band during the book-building process.
7. Determination of Issue Price: Based on investor demand and bids received, the final issue price and quantity are decided.
8. Filing of Final Prospectus: After the price discovery process, the company files the final prospectus, incorporating the final details, with the ROC before the allotment of shares.

Example

Suppose XYZ Ltd. plans to go public. It files a Red Herring Prospectus with SEBI, mentioning a price band of ₹100–₹120 per share but not the exact issue price. During the book-building process, investors submit bids within this range. After analysing demand, the company finalises the price at ₹115 per share. Subsequently, a final prospectus with the confirmed price and share details is filed with the ROC.

Difference Between Red Herring Prospectus and Final Prospectus

Regulatory Framework

In India, the issuance of a Red Herring Prospectus is governed by:

• Companies Act, 2013 – Section 32
• SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018
• Securities Contracts (Regulation) Act, 1956

These regulations ensure that companies disclose all material information to protect investor interests and maintain transparency in capital market operations.

Advantages of a Red Herring Prospectus

• Transparency: Provides investors with detailed, reliable information before the public issue.
• Market Feedback: Helps companies gauge investor sentiment and demand before setting the final issue price.
• Regulatory Compliance: Fulfils mandatory SEBI disclosure norms, enhancing investor confidence.
• Flexibility in Pricing: Allows issuers to finalise the price after receiving bids through the book-building process.

Limitations

• Incomplete Information: Lacks final issue price and quantity, which may limit investor decision-making initially.
• Time-Consuming Process: Preparation, review, and approval involve multiple stages.
• High Costs: Requires professional services from underwriters, lawyers, and auditors.