How to Read an IPO Prospectus (DRHP & RHP)

Whenever a company plans an Initial Public Offering (IPO) in India, it is mandated by the Securities and Exchange Board of India (SEBI) to submit detailed disclosures. This begins with the Draft Red Herring Prospectus (DRHP), which is reviewed by SEBI and made available for public comments. Once regulatory feedback is addressed and dates are finalized, the issuer files the final Red Herring Prospectus (RHP), which contains the price band, issue timeline, and updated financials.

While prospectuses often exceed 400 to 700 pages, retail investors do not need to read every legal clause. By focusing on six core chapters, you can quickly determine whether an IPO offers genuine long-term value or is an overpriced exit for early investors.

1. Fresh Issue vs. Offer for Sale (OFS)

The very first detail to verify on the cover page is the breakdown of the total issue size:

• Fresh Issue: New shares created by the company. The proceeds go directly into the company's bank account to finance capital expenditure (capex), pay down debt, or fund organic expansion. A high fresh-issue component usually signals growth orientation.
• Offer for Sale (OFS): Existing promoters, private equity funds, or early venture capitalists sell their existing shares. None of the OFS proceeds flow to the company; the cash goes straight to the selling shareholders. While some OFS is normal for liquidity, an issue that is 100% OFS with full promoter exit warrants strict scrutiny.

2. Objects of the Issue

SEBI requires companies to itemize exactly how every rupee raised through the fresh issue will be deployed. Check whether funds are allocated towards productive, revenue-generating activities such as:

1. Setting up new manufacturing plants, warehouses, or technology infrastructure.
2. Repaying high-cost bank debt, which immediately reduces finance costs and boosts net profit margins.
3. Funding working capital needs for verified order-book expansion.
4. General Corporate Purposes (GCP): SEBI caps GCP at 25% of the total issue size. If a company allocates the maximum allowed to vague "general corporate" activities without clear milestone breakdowns, ask why specific capital plans are lacking.

3. Internal and External Risk Factors

The "Risk Factors" section is typically located near the beginning of the document. Legal advisors are obligated to disclose every conceivable operational, regulatory, and litigation risk. Look specifically for:

• Customer Concentration: Does the company generate more than 40-50% of its total revenue from just top 3 or top 5 clients? Losing a single contract could destroy profitability.
• Supplier / Raw Material Dependencies: Are key raw materials imported from a single geographic source subject to currency fluctuations or geopolitical embargoes?
• Pending Litigations and Tax Demands: Check the monetary exposure of ongoing tax disputes, criminal proceedings, or promoter disputes against the company's net worth.
• Negative Operating Cash Flows: Check if operating cash flow (CFO) is consistently negative despite positive accounting profits (PAT), which can indicate aggressive revenue recognition.

4. Financial Statements (Restated Financial Information)

Examine the past 3 fiscal years (and latest stub period) of restated audited financials. Key metrics to evaluate include:

• Revenue Growth Trajectory (CAGR): Is top-line expansion steady and organic, or was there an artificial revenue spike right in the pre-IPO year?
• EBITDA & PAT Margins: Are operating margins expanding or compressing? Look out for one-off exceptional items (like asset sales or tax reversals) that inflate net profit.
• Return on Net Worth (RoNW) / Return on Equity (RoE): Healthy businesses typically sustain an RoE above 15-20%.
• Debt-to-Equity Ratio: High leverage combined with rising interest rate cycles puts company cash flows under stress.

5. Promoter Pedigree and Related-Party Transactions

Evaluate who runs the business and how governance is structured:

• Promoter Track Record: Have the promoters faced SEBI debarment, banking wilful default classifications, or previous company insolvencies?
• Related-Party Transactions (RPT): Does the listed entity buy goods or lease properties from private entities owned by the promoter's family at above-market prices? Excessive RPTs are a major red flag for siphoning corporate profits.
• Pre-IPO Placements & Weighted Cost of Acquisition: Check the average acquisition cost of shares for promoters and institutional investors compared to the IPO floor price. If anchor investors received shares at ₹30 two months ago and the public is asked to pay ₹150, evaluate if the valuation jump is justified.

6. Peer Group Comparison and Valuation Multiples

Every RHP includes a table comparing the issuer with listed industry peers on key parameters:

• Price-to-Earnings (P/E) Ratio: Compare the issuer's post-issue P/E against the industry average.
• Enterprise Value to EBITDA (EV/EBITDA): Useful for capital-intensive manufacturing and infrastructure firms.
• Price-to-Book (P/B) Ratio: Critical benchmark for banks, NBFCs, and financial institutions.

If the issuing company demands a 50x P/E while established, higher-margin market leaders trade at 30x, the issue may leave little margin of safety for retail investors on listing day.