Red Herring Prospectus Meaning (RHP)
Red Herring prospectus refers to the preliminary prospectus filled by the company with SEC generally concerning the initial public offering by the company that contains the information of the company’s operation. Still, it does not include details of the prices at which securities are issued and their numbers.
A disclosure is made in red letters that the company will not attempt to sell the securities before the approval of the SEC and hence the name ‘Red Herring.’
Let us check how such information is disclosed in the Red Herring Prospectus of Twitter, Inc. The information in this preliminary prospectus is not complete and may be changed. This preliminary prospectus is not an offer to sell, nor does it seek an offer to buy these securities in any jurisdiction where the offer or sale is not permitted. These securities may not be sold until the registration statement filed with the Securities and Exchange Commission is effective.
Table of contents
- The term “Red Herring Prospectus” refers to the organization’s inaugural prospectus filed with the SEC on the company’s first public offering, which includes information on the company’s activities.
- The corporation declares in red that it would only attempt to offer the securities after gaining SEC approval, thus the nickname ‘Red Herring.’ These securities may be provided once the Securities and Exchange Commission has approved the registration statement.
- The firm cites the total amount it seeks to raise from the market in its Red Herring Prospectus, leaving out specifics such as the price at which the shares will be sold or the number of shares the company proposes to offer to the public.
The initial prospectus and the subsequent drafts submitted to the SEC for obtaining approval for public release may be included in the broad term, Red Herring.
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Broad Contents of Red Herring Prospectus (RHP)
- General definitions and abbreviations
- Purpose of the issue
- Risk factors
- About the company
- Legal and other information
- Disclosure of any option agreementOption AgreementThe option agreement is a legally binding contract between two parties, one seller and the other buyer of the option, in which one party has the right but not the obligation to buy or sell the asset and each party's responsibilities to the other, which must be honored until either party exits the agreement.
- Underwriter’s commission and discounts
- Promotion expenses
- Net proceedsNet ProceedsNet proceeds are the final amount of money that a seller is entitled to receive with the disposal of an asset less all the related expenses like commission, fees that are already paid, and calculated by deducting all the selling costs from the sale price of an asset. to the issuing company
- Balance sheetBalance SheetA balance sheet is one of the financial statements of a company that presents the shareholders' equity, liabilities, and assets of the company at a specific point in time. It is based on the accounting equation that states that the sum of the total liabilities and the owner's capital equals the total assets of the company.
- Earnings statements for the last three years, if available
- Names and addresses of all officers, directors, underwritersUnderwritersThe underwriters take the financial risk of their client in return of a financial fee. Market Makers like financial institution and large banks ensure that there is enough amount of liquidity in the market by ensuring that enough trading volume is there., and stockholders owning 10% or more of the currently outstanding stock
- Copy of the underwriting agreement
- Legal opinion on the issue.
- Copies of the articles of incorporationArticles Of IncorporationArticles of incorporation are also known as a corporate charter or a certificate of incorporation, and it can be defined as a set of documents that are filed with a government institution for the purpose of legally documenting the foundation of a company. It is mandatory for the ones who are willing to incorporate a business.
Where can an Investor find an RHP?
- The company’s website
- The website of the SEC – www.sec.gov
- The website of the merchant banker.
Significance of Red Herring Prospectus
- Usually, companies seeking to list themselves on the stock exchangesThemselves On The Stock ExchangesStock exchange refers to a market that facilitates the buying and selling of listed securities such as public company stocks, exchange-traded funds, debt instruments, options, etc., as per the standard regulations and guidelines—for instance, NYSE and NASDAQ. for the first time do not directly offer their shares at a predetermined price. Some regulations require them to go through the book-buildingBook-buildingBook Building is a process that helps companies in determining the price of their security when its shares are offered for sale in an IPO with the help of an investment bank. Major stock exchanges and regulators recommend this process because it is the most efficient mechanism for pricing securities in the market. process.
- They fix a price bandPrice BandThe price band refers to an underlying security’s fixed value range specified by the stock exchange or seller. for their offer, call bids from investors, and based on the bids obtained, they gather all the information and then arrive at an offer price. It makes it necessary to issue the red-herring prospectus.
- A company launching an IPO does not know the price at which it will be able to sell shares. It may, at the most, know the total sum that it requires for running the business, capital expansion, writing offWriting OffWrite off is the reduction in the value of the assets that were present in the books of accounts of the company on a particular period of time and are recorded as the accounting expense against the payment not received or the losses on the assets. excess debt from the balance sheet, etc.
Why Should Companies Go for RHP?
There are many regulatory requirements for listed companies that a company should comply with the exchange commission, so there would be a lot of information out there about such companies that will help investors make sound investing decisions.
But regarding unlisted companies that are set to go public for the first time, investors would not have any information based on which they can make decisions.
It is the reason RHP was introduced.
The SEC goes through the prospectus, raises queries in case of any doubts, and seeks clarifications. Hence, a company seeking to go public will first file the RHP. After this, the approval process will take place.
- It acts as a source of information concerning the offering that the company decides.
- It contains important information regarding:
- the company
- the financial condition of the company
- information with regards to the manner of utilization of the proceeds
- financial statements of the companyFinancial Statements Of The CompanyFinancial statements are written reports prepared by a company's management to present the company's financial affairs over a given period (quarter, six monthly or yearly). These statements, which include the Balance Sheet, Income Statement, Cash Flows, and Shareholders Equity Statement, must be prepared in accordance with prescribed and standardized accounting standards to ensure uniformity in reporting at all levels.
- management personnel of the company
- majority shareholders (holding 10% or more of the shares)
- unresolved litigations of the company
- risk factors
- and other appropriate information about the company, which helps investors make informed decisions.
- If investors notice any divergence, they can report the same to the SEC.
Other Important Points about RHP
- Red Herring prospectus (or RHP) is an initial prospectus filed by the company with the Securities and Exchange Commission (SEC). It is considered the first step to raising capital via Initial Public Offering (IPO).
- Though it does not disclose the details of price, the number of shares being offered, the coupon of the issue, or the size, it has the details regarding the company’s operation and financial position and standing.
- After being authorized by the SEC, a red herring prospectus tends to become the company’s final prospectus. It can be utilized to seek investments and hence carries the same liability as a normal prospectus.
- Dissimilarities between the red herring prospectus and the prospectus shall be called for attention in the prospectus.
- As mentioned above, it does not contain the quantum and price of securities offered by the company.
- The public offering of shares can be completed only after the Final prospectus is prepared and distributed, containing the price and the number of shares issued.
In short, in the Red Herring prospectus, the company only mentions the total sum it plans to raise from the market, leaving out details such as the price at which the shares will be issued, or the number of shares the company proposes to issue to the public.
Investors should look into major disclosures such as the company’s operations, its financials, comparison with the competitors in the industry, various risk factors that may threaten the businessRisk Factors That May Threaten The BusinessRisk factors in Business are constituents, circumstances, or causes, responsible for interruption, or, disrupting the business activities or operations, expectations, plans, objectives, or strategies of a business or an investor., how the company aims to utilize the amount raised, etc. It would be in the best interest of the investors to read the RHP exhaustively, understand the contents, and then conclude.
Frequently Asked Questions (FAQs)
A red herring prospectus, commonly referred to as an offer document, is a document submitted by a company with the Securities and Exchange Board of India (SEBI) when it intends to raise funds from the public by selling shares of the firm to investors.
A red herring prospectus can provide information about a future offering that a specific firm is presently developing. Prospectus versions that the SEC has not thoroughly vetted may portray a firm “too” favorably.
Investing in securities carries inherent risks, and the decision to invest should be based on thorough research, including the information provided in the final prospectus. The Red Herring prospectus serves as a starting point for due diligence but only contains some of the necessary details to make an informed investment decision.
This article has been a guide to what is Red Herring Prospectus and its Meaning. Here we discuss the contents of the red herring prospectus and why companies go for RHP. You can learn more about accounting from the following articles –