How to Read a DRHP: 10 Sections to Check Before an IPO

Key takeaways

You don’t need to read every page of a DRHP. Start with the business overview, financials, objects of the issue, promoters, risk factors and valuation.
Check whether the IPO is a fresh issue, an offer for sale (OFS) or both, because only the money from a fresh issue goes to the company.
Review revenue, profit, debt and cash flows over several years instead of judging the company on one year’s numbers.
A red flag, such as heavy customer concentration or pending litigation, is a reason to look closer, not automatic proof that an IPO should be avoided.
The DRHP is a draft, so always read the latest RHP or final offer document before you apply for an IPO.

When a company decides to go public, investors tend to pay attention to the price band, the number of shares offered in the subscription and the expectations for the listing. But this information is not necessarily enough to understand how a business functions, how it generates income and what risks it is exposed to. Understanding how to go through a DRHP can help you analyse these factors before determining if an IPO is worth considering.

One of the most important documents that is available during the IPO is the Draft Red Herring Prospectus (DRHP). It may be fairly long and technical, but you don't need to read every page in a detailed manner. You can instead focus on the sections that explain the business, the financials, IPO structure, promoters, risks and valuation. Let us try to understand through this blog the correct way to read a DRHP in order to make informed investment decisions.

What is a DRHP?

A Draft Red Herring Prospectus (DRHP) is a draft offer document submitted by a company intending to raise capital by a public issue. It includes detailed information regarding the company, its business, financial performance, promoters, risks and proposed issues. SEBI's public-issues section publishes the draft offer documents submitted to SEBI, and exchanges also make offer documents available.

The DRHP does not necessarily represent the final information that investors will use once the IPO is open. Details can be updated through subsequent filings, addenda and the final offer documents. Hence, investors should refer to the latest available RHP / offer document before making an application.

Why should investors read DRHP before IPO?

A DRHP can help investors see beyond the hype of an IPO and understand the company from a fundamental level. It can respond to basic but important questions like what the business does, how it makes money, whether the finances are getting better and why it needs to raise money. It also includes details on promoters, shareholders, material risks and other aspects that may have an impact on the business.

Reading a DRHP does not give an assurance that an IPO will do well after listing. Rather, it provides investors with additional information to evaluate an opportunity, risks and valuation before making a decision. This makes the document particularly useful for investors who wish to do their own research and not just follow the market sentiments blindly.

How to read a DRHP?

Here are the 10 sections that investors should check while reading a DRHP:

1. Check the issue details first

The first step is to understand the basic structure of the IPO, its total size of the issue, number of shares offered, face value and, if available, the price band. Pay particular attention to whether the issue consists of a fresh issue, an offer for sale (OFS), or a combination of both.

A fresh issue consists of the issue of new shares with the company receiving the money. In an OFS, existing shareholders are selling their shares, so the proceeds are flowing to those who are selling their shares, and not to the company.

2. Understand what the company does

Then, head to the business overview and attempt to understand the company in simple terms. Examine its key products or services, customers served, geographic location, revenue streams and competitive advantage.

If you cannot understand how the company is earning money, it is time to go back and understand the business before looking at the valuation.

3. Look at the company's industry and market

A company's financial performance should be viewed in the context of the industry in which it operates. Analyse the industry size, growth factors, competition, regulatory factors and key risks.

The DRHP may include industry projections and estimates, but these are not guarantees of future performance. Assess the company's actual performance relative to such projections and determine if the assumptions seem appropriate.

4. Analyse the financial statements

Financial statements are among the most important sections when learning how to read DRHP. Analyse revenue, operating profit/EBITDA, PAT, margins, borrowings, cash flows and relevant return ratios on a multi-year financial basis.

Don't just look at the profit of the current year. For instance, a company that is seeing a dramatic increase in revenue but has seen a corresponding fall in operating cash flow or is showing inconsistent profitability may need to be examined more closely before any conclusions are drawn about the company.

5. Understand why the company is raising money

The objects of the issue section explains how the company proposes to use the funds raised. Some of the common uses may be capital expenditures, repayments of debts, working capital, acquisitions or general corporate uses.

Simply ask one question: What will this IPO money be used for? Knowing this can help you see the difference between capital that can be used for future expansion of the business and an OFS in which current shareholders are selling.

6. Study the promoters and existing shareholders

The DRHP includes details about the promoters of the company, promoter group and existing shareholders. Check their backgrounds, shareholding and any changes in ownership that may be relevant to the IPO.

If the issue includes an OFS, understand who is selling and how much they are selling. While a large OFS does not necessarily indicate a bad signal, investors should know the reasons behind the decision by existing shareholders to sell off and where the IPO proceeds go.

7. Read the risk factors carefully

The risk factors section can be long, but it's important and worth reviewing. SEBI's disclosure framework requires material risks to be disclosed based on their materiality and risk disclosures may include company specific risks, industry risks, financial risks, legal risks, etc.

Consider risks including customer concentration, supplier dependence, debt, regulatory requirements, litigation, and factors that have or could have a material effect on revenue or cash flows.

Related-party transactions refer to transactions which are done between the company and its related parties. The related parties can include promoters, directors, subsidiaries or related entities. Consider the nature and volume of these transactions and whether they are material to the business.

The DRHP can also include details of any of the company’s pending litigation and regulatory proceedings. The presence of a legal case doesn't necessarily indicate a company's quality. Nevertheless, investors should take into account the type of case and its potential effect on the company's financials or operations.

9. Look at customer and supplier concentration

If a company relies on a few customers or suppliers majorly, there may be extra business risk. Check if a large percentage of revenue is generated from a few customers and/or if key inputs or services are provided by a few suppliers.

It matters because losing an important customer or being disrupted due to a big supplier can impact revenues, margins or operating processes.

The DRHP can act as a guide for investors to evaluate valuation, though the final price band can be revealed at a later stage. Key metrics to look at include earnings per share (EPS), price-to-earnings (P/E), book value, return on equity (ROE) and return on capital employed (ROCE).

Don't disqualify an IPO just because the P/E is too high or too low. Compare the valuation with relevant listed peers and also consider the company's growth, profitability, business model and industry characteristics.

DRHP red flags investors should not ignore

While reading the DRHP document, investors should pay closer attention to:

Persistent losses or highly volatile profits
Weak or negative operating cash flow
High or rapidly increasing debt
Heavy customer concentration
Dependence on a small number of suppliers
Significant related-party transactions
Material litigation or regulatory issues
Promoter share pledging, where applicable
Large OFS with limited fresh capital for the company
Major changes in business strategy or financial performance

A red flag is a reason to investigate further, not automatic proof that an IPO should be avoided. The importance of any issue depends on its size, context and potential impact on the company's future performance.

DRHP vs RHP

To make it easier for you, here is the difference between DRHP and RHP:

DRHP	RHP
Draft offer document	Offer document issued closer to the IPO
Filed during the IPO preparation process	Contains updated issue information
Contains detailed company and issue disclosures	Reflects information available closer to the public issue
Price band may not yet be finalised	Pricing and final issue details are provided as applicable

SEBI's current public-issues database separately lists draft offer documents and red herring documents, showing that investors should distinguish between the different stages of IPO documentation.

How to read a DRHP without getting overwhelmed?

On the first read-through, you don't need to read a DRHP line by line. Begin with the table of contents and go to the business overview, financial statements, objects of the issue, promoters, risk factors and legal information.

It can also be used to prepare a one-page summary on business, revenue and profit trend, debt, IPO size, fresh issue/OFS, use of proceeds, major risks, promoter's holding and valuation of the company. This facilitates the comparison of various IPOs with a common set of parameters.

A simple 15-minute DRHP reading checklist

If the document feels overwhelming, use this sequence:

Step 1: Understand the business.
Step 2: Check fresh issue versus OFS.
Step 3: Review revenue and profit trends.
Step 4: Check debt and cash flows.
Step 5: Understand the use of IPO proceeds.
Step 6: Research promoters and selling shareholders.
Step 7: Read the major risk factors.
Step 8: Check related-party transactions and litigation.
Step 9: Assess valuation against relevant peers.
Step 10: Read the latest RHP or offer document before applying.

This approach lets you focus on the information most relevant to an investment assessment instead of reading hundreds of pages from beginning to end. You can then return to specific sections if something requires deeper research.

How DRHP analysis can help IPO investors?

A DRHP is a document that offers information, but investors must also understand what that information means for the business. Ask if the business makes sense, if financial performance supports growth, if the company is cash-generating and if the IPO proceeds have a clear purpose.

Also think about if the company's risk is material, the positioning of promoters and existing shareholders and if the valuation is in line with the company's fundamentals. DRHP analysis is a component of the IPO research and will not be able to predict the listing gains and future returns.

Conclusion

Understanding the correct way of reading a DRHP can help in IPO research to be more systematic and less influenced by market noise. You don't have to learn all the technical expressions or read every page and every word thoroughly to discover what is most important.

The basic structure is to comprehend business knowledge, do financial analysis, examine IPO structure, check on promoters, go through the risks, see valuation, and read the latest offer document. This can enable investors to carry out more effective due diligence before determining whether they wish to consider a company for an IPO.

FAQs

What is a DRHP in an IPO?

A Draft Red Herring Prospectus (DRHP) is a draft offer document that provides extensive information on a company that is seeking a public issue. It includes information on the business, the finances, promoters, the issue structure, and the risks.

Is it necessary to read the entire DRHP before investing?

Whilst reading the entire document can provide comprehensive information, one may start by reading the business, financials, objects of the issue, promoters and risks and valuation-related sections.

What are the most important sections of a DRHP?

Amongst the key sections are business overview, financial statements, objects of the issue, promoter information, risk factors, legal information, and valuation-related disclosures.

What is the difference between DRHP and RHP?

A DRHP is the draft offer document submitted during the IPO process. On the other hand, an RHP is issued near the time of the public offering, containing updated information.

Where can I find the DRHP of a company?

DRHPs are available on official platforms like the SEBI and stock-exchange offer-document pages. NSE has an official database of issuer offer documents, and companies can also post the IPO documents on their investor-relations websites.

How to read a DRHP?