Red Herring Prospectus Meaning (RHP)
Red Herring prospectus refers to the preliminary prospectus which is filled by the company with SEC generally with respect to the initial public offering by the company that contains the information of the operation of the company but 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 prior to 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. These securities may not be sold until the registration statement filed with the Securities and Exchange Commission is effective. 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.
Not only the initial prospectus but the following drafts submitted to the SEC for obtaining the approval for public release may be included in the broad term, Red Herring.
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 agreement
- Underwriter’s commission and discounts
- Promotion expenses
- Net proceeds to the issuing company
- Balance sheet
- Earnings statements for the last 3 years, if available
- Names and address of all officers, directors, underwriters, 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 incorporation.
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 exchanges for the first time do not directly offer their shares at a predetermined price. Some regulations require them to go through the book-building process.
- They fix a price band 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. This makes it necessary to issue the red-herring prospectus.
- A company launching an IPO does not really 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 off excess debt from the balance sheet, etc.
Why Should Companies Go for RHP?
For listed companies, there are a lot of regulatory requirements that a company should comply with the exchange commission so there would be a lot of information out there about such companies which 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 on the basis of which they can make decisions.
This is the reason RHP was introduced.
Hence, a company seeking to go public will first file the RHP. The SEC goes through the prospectus, raises queries in case of any doubts and seeks clarifications. After this, the approval process will take place.
- It acts as a source of information with respect to the offering that is decided by the company.
- It contains significant 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 company
- 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 of 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) and is considered to be 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 of the issue, it has the details regarding the company’s operation and financial position and standing.
- A red herring prospectus after being authorized by the SEC tends to become the company’s final prospectus and it can be utilized to seek investments and hence carries the same liability as that of 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 being offered by the company.
- The public offering of shares can be completed only after the Final prospectus would be prepared and distributed which shall contain the price and the number of shares issued.
In short, in Red Herring prospectus the company only mentions the total sum that it plans to raise from the market leaving out details such as the price at which the shares are going to 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 business, how the company aims to utilize the amount so raised, etc. It would be in the best interest of the investors to read the RHP exhaustively, understand the contents and then arrive at a conclusion.
This 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 –