When a company decides to go public through an Initial Public Offering (IPO), it must provide prospective investors with detailed information about its business, financial standing, and associated risks. One of the most crucial documents in this process is the Red Herring Prospectus (RHP). This preliminary document offers insights into the company’s financial health, market presence, and future growth strategies. However, unlike the final prospectus, it does not specify the exact price of shares or the total number of shares offered. These details are determined later based on investor interest during the book-building process.
The Companies Act, 2013, under Section 32, governs the issuance of a Red Herring Prospectus, ensuring that companies provide transparent and reliable disclosures. Additionally, the Securities and Exchange Board of India (SEBI) plays a vital role in regulating the document, ensuring compliance with capital market laws. The RHP serves as a bridge between the company and potential investors, allowing them to assess whether they wish to participate in the IPO.
A Red Herring Prospectus is a document that a company files before launching an IPO. It contains a detailed overview of the company’s operations, financial history, competitive positioning, and growth strategy. The purpose of this document is to help investors evaluate the company before making investment decisions. However, since it does not contain the final offer price or total number of shares, it is considered a draft version of the final prospectus.
The name “Red Herring” originates from the red disclaimer on the cover page of the document, indicating that the information is subject to modifications. After gathering investor feedback through the book-building process, the company finalizes its offer price and files a final prospectus with the Registrar of Companies (RoC).
Since the document is subject to updates, investors must stay informed about any changes before making investment commitments. The RHP helps companies gauge market demand and determine a fair issue price based on investor appetite.
Legal Framework of Red herring prospectus
The issuance of a Red Herring Prospectus is governed by Section 32 of the Companies Act, 2013. This section provides that a company may issue a Red Herring Prospectus before filing the final prospectus with the RoC. The document must include all relevant disclosures required under the law, except for details such as pricing and the total number of shares.
The law mandates that the RHP be filed with SEBI and the RoC at least three days before the IPO opens for subscription. This ensures that regulatory authorities have sufficient time to review the document and raise any concerns. Once the IPO process is complete, the company must submit a final prospectus with the actual pricing and allocation details.
These provisions ensure that investors receive complete and up-to-date information about the company. By requiring companies to provide accurate disclosures, the law aims to protect investors from misleading claims and maintain transparency in capital markets.
Key Components of Red herring prospectus
A Red Herring Prospectus includes several crucial sections that help investors assess a company’s financial and operational standing. One of the most important sections is the business overview, where the company provides details about its history, industry position, product offerings, and competitive advantages. This section also outlines the company’s future strategy, helping investors understand its long-term vision.
The financial information section presents the company’s audited profit and loss statements, balance sheets, and cash flow statements. Investors closely examine these figures to assess the company’s financial health, revenue trends, and debt obligations. Strong financial performance can attract more investors, whereas declining profits or excessive debt may raise concerns about the company’s stability.
Every investment carries risks, and companies must clearly outline potential challenges in the risk factors section. These risks may be related to market competition, regulatory hurdles, economic downturns, or operational challenges. Investors must carefully analyze this section to understand the potential threats to the company’s success.
The use of IPO proceeds section explains how the company plans to utilize the funds raised from the IPO. Some companies use the proceeds to expand their operations, invest in research and development, or repay outstanding debts. A well-defined utilization plan can boost investor confidence, while vague or unclear plans may create skepticism.
A company’s management and promoters also play a crucial role in investor decision-making. The RHP provides details about the background, experience, and shareholding patterns of key executives and promoters. Investors prefer companies with strong leadership and a credible track record, as this increases the likelihood of long-term success.
Companies must also disclose any pending litigations, regulatory compliance issues, or taxation matters that could impact their business. Legal challenges can create uncertainty, and investors must weigh these risks before investing.
Since the final price of shares is determined through the book-building process, the RHP explains how this mechanism works. Investors submit bids within a specified price range, and based on demand, the company finalizes the offer price. This method ensures that shares are fairly priced according to market conditions.
Role of SEBI in Regulating the Red Herring Prospectus
The Securities and Exchange Board of India (SEBI) plays a crucial role in overseeing the issuance of a Red Herring Prospectus. SEBI ensures that companies provide accurate and complete disclosures to protect investor interests. If SEBI finds any misleading statements or inadequate disclosures, the company may be required to revise and refile the document.
Under the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018, companies must meet specific eligibility criteria before filing an RHP. These regulations govern aspects such as minimum public shareholding, promoter lock-in requirements, and financial disclosures. By enforcing these rules, SEBI ensures that companies entering the stock market maintain high transparency and governance standards.
Importance of Red herring prospectus
For companies, an RHP provides an opportunity to gauge investor sentiment and test market demand before finalizing their IPO pricing. By observing investor responses, companies can make informed decisions about how to structure their share offering. This document also helps businesses comply with legal and regulatory requirements, ensuring a smooth IPO process.
For investors, the RHP serves as a valuable resource for understanding a company’s fundamentals. By analyzing financial statements, risk disclosures, and business strategies, investors can determine whether an IPO is a worthwhile investment. Since the book-building process allows pricing to be market-driven, investors can participate in fairly valued share offerings.
Red Herring Prospectus vs. Final Prospectus
The primary difference between an RHP and a final prospectus is that the latter includes definitive pricing and allocation details. While the RHP provides an overview of the company’s operations and financials, it leaves out key elements such as the final offer price and the number of shares issued. These details are included in the final prospectus, which is filed after the IPO closes.
Conclusion on Red herring prospectus
The Red Herring Prospectus plays a fundamental role in the IPO process by providing detailed yet preliminary information about a company. Governed by Section 32 of the Companies Act, 2013, and regulated by SEBI, it ensures that companies follow transparent and fair disclosure practices. Investors must carefully examine the RHP to make informed decisions and assess whether a particular IPO aligns with their investment goals.
As IPOs continue to be a popular method for companies to raise capital, the Red Herring Prospectus remains a cornerstone document in the Indian financial markets. By understanding its significance and key components, both companies and investors can navigate the IPO process with greater confidence and clarity.
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About the Author
This article is written by Advocate Shruti Goyal. Advocate Shruti Goyal has done her LLB from Dr Bhim Rao Ambedkar Law University and a Law graduate currently practicing as an Advocate in High Court and Supreme Court of India.