Definition
A Red Herring Prospectus, in finance, is a preliminary document filed by a company with the Securities and Exchange Commission (SEC) before its Initial Public Offering (IPO). It details the company’s business operations, financial status, and information about its forthcoming IPO, but it doesn’t include crucial details like the number of shares to be issued and the issue price. This document is named “Red Herring” because of a bold red disclaimer stating that the information is incomplete and subject to change.
Key Takeaways
- A Red Herring Prospectus is a document provided as part of an initial public offering (IPO) or other public offering of securities, which contains significant information about the company’s operations, financial condition, and future prospects, but does not mention the exact price or the number of shares to be sold.
- The term “Red Herring” comes from the provision that in the preliminary stage, a disclaimer in red is required to be printed on the cover page which ingeminates that this is not the final official document. Once approved from the associated authority, the final prospectus is published with detailed price bands and the number of shares to be issued.
- Red Herring Prospectus is an important document for investors as it helps them make informed decisions in relation to the investment. This document is filed with the respective securities regulatory body, ensuring transparency and accountability of the issuing company.
Importance
The term “Red Herring Prospectus” is crucial in finance because it pertains to a preliminary document filed by a company prior to its initial public offerings (IPO). This document, filled with the Securities and Exchange Commission (SEC), provides crucial details about the company’s business operations, financial conditions, strategy, management, and the intended usage of the funds raised by the IPO.
However, it doesn’t contain two critical pieces of information – the number of shares to be issued and the price range for such shares, leading somewhat to a “red herring” diversion.
This helps potential investors to make informed decisions while also protecting the company’s strategic information until the final prospectus is released.
Hence, it is a critical step in ensuring transparency and accountability in financial markets.
Explanation
A Red Herring Prospectus is an initial prospectus that a company issues containing important information about the business’s operations and financials, but without specifics about the issue price and number of shares to be issued to the public. This significant document serves a couple of crucial purposes.
One, it acts as a tool to solicit interest in an upcoming initial public offering (IPO) or any other securities offering. Two, it provides key details — such as the company’s operational history, management team, and risk factors — that investment analysts can use to evaluate the company’s potential and prospects.
The purpose of the Red Herring Prospectus is to give potential investors an understanding of the company’s business model and the risks associated with investing, thus facilitating a well-informed investment decision. Moreover, companies can adjust their offering price or the number of securities issued based on feedback they receive from the market during this preliminary release phase.
The name ‘red herring’ comes from the disclosure statement in bold red type on the cover of the document stating that the information within includes incomplete or subject to change information.
Examples of Red Herring Prospectus
WeWork’s Filing: In 2019, WeWork, a shared workspace company, filed a red herring prospectus as part of its initial public offering (IPO) process with the U.S. Securities and Exchange Commission (SEC). The document detailed the company’s financial health, business model, and potential risk factors, but it did not include a specific share price or the number of shares to be sold. The company later had to withdraw its IPO filing due to several issues that came up, including questions about its valuation and business model.
Facebook’s IPO: In 2012, Facebook Inc. filed a red herring prospectus as part of its highly anticipated IPO process. The document offered potential investors a first look at the company’s finances and operations. The red herring document did not disclose how many shares would be offered or the price range for the IPO.
Alibaba’s IPO: In 2014, Alibaba Group Holding Limited, a Chinese multinational conglomerate specializing in e-commerce, retail, and technology, filed its red herring prospectus before the company’s IPO in the United States. The filing detailed the company’s financial position, business model, and potential risk factors. It provided potential investors with essential information ahead of one of the biggest IPO’s ever, but it did not include the price range or the number of shares to be offered.
Red Herring Prospectus FAQ
What is a Red Herring Prospectus?
A Red Herring Prospectus, also known as an RHP, is a preliminary document filed by a company with the Securities and Exchange Board of India (SEBI) and the stock exchange(s) regarding its proposed Initial Public Offering (IPO). It contains all the relevant details about the business and financials but does not include information about the price or number of shares being offered.
Why is it called a Red Herring Prospectus?
The term ‘Red Herring’ is derived from the red warning sign indicating that the company has not completed its issue of securities, and that the information contained may be subject to change. This name points to the document’s preliminary nature.
What information does a Red Herring Prospectus contain?
The RHP contains detailed information about the company’s operations, its promoters, the reason for raising funds, how the funds will be used, and details about the company’s financial health and main risk factors. It is a crucial research document for potential investors. However, it does not contain the price or number of shares being offered.
How important is a Red Herring Prospectus for an investor?
The RHP is a very important document for potential investors as it contains detailed disclosures about the company. By reading the RHP, investors can get a deep insight into the company’s business, its financial health, management quality, how the funds raised will be used, and the main risk factors the company faces.
Where can I find the Red Herring Prospectus of a company?
The Red Herring Prospectus of a company can be found on the official website of the SEBI, the respective stock exchange(s), and the website of the company going for an IPO.
Related Entrepreneurship Terms
- Initial Public Offerings (IPOs)
- Securities and Exchange Commission (SEC)
- Investment Due Diligence
- Financial Disclosure
- Underwriting Process
Sources for More Information
- Investopedia: A comprehensive online financial education platform that provides in-depth definitions, articles, tutorials related to investing, finance, and market news.
- Corporate Finance Institute: Offers range of online courses and resources in finance, digital marketing, analytics, and has informative articles on finance terminology.
- NASDAQ: As a national securities exchange, it has wealth of information about different financial instruments, regulation issues, finance news, and knowledge resources.
- The Economic Times: A popular financial news website offers breaking news, analysis, and opinion on financial terminologies and trends worldwide.
