How to Read an IPO RHP: 15 Red Flags Most Investors Miss

How to Read an IPO RHP: 15 Red Flags Most Investors Miss

An IPO may look attractive because of strong subscription numbers, a popular business, famous investors or a high grey market premium.

But the document that can tell you much more about the actual business is usually sitting unread: the Red Herring Prospectus, or RHP.

According to SEBI's guide to understanding an offer document, an offer document contains information on risks, financial statements, promoters, related-party transactions, litigation, use of IPO proceeds and the basis for the issue price.

Learning to read those sections can help you separate a genuinely strong IPO from a good story carrying hidden risks.

Why it matters

An RHP is not a marketing brochure.

Under Section 32 of the Companies Act, 2013, a red herring prospectus carries prospectus-related obligations even though some final issue details may not yet be included.

There is another important misconception to remove first:

SEBI does not approve an IPO as a good investment.

IPO documents themselves explicitly state that the shares have not been recommended or approved by SEBI and that investors must make their own assessment of the company and its risks.

So instead of asking only:

“What is the GMP?”

A better question is:

“What is the RHP telling me that the market hype is not?”

Key facts

• The RHP contains sections covering risk factors, business, financials, promoters, related parties, litigation and objects of the issue, as explained in SEBI's offer document guide.
• Investors are specifically advised in offer documents to carefully read the Risk Factors before investing.
• The Basis for Issue Price section helps investors compare the IPO valuation with earnings, return ratios, net asset value and peer companies.
• The Objects of the Issue section explains where money raised through the fresh issue is expected to be used.
• Legal proceedings involving the company, promoters and other relevant parties can appear in the Outstanding Litigation and Material Developments section.

15 IPO RHP red flags to check

1. Revenue is growing, but operating cash flow is not

This is one of the first things to check.

A company may report:

• Rising revenue
• Rising EBITDA
• Rising PAT

Yet cash generated from operations may remain weak or negative.

That can happen when customers have not actually paid the company.

Compare:

Profit after tax vs cash flow from operating activities

If PAT repeatedly rises while operating cash flow remains poor, investigate further.

Possible reasons include:

• Rapidly rising receivables
• Unsold inventory
• Aggressive revenue recognition
• Large working-capital requirements

One weak year is not automatically a red flag. A repeated mismatch deserves attention.

2. Trade receivables are growing much faster than sales

Suppose revenue rises 20%, but receivables rise 70%.

The obvious question is:

Why is the company finding it increasingly difficult to collect cash from customers?

Check the balance sheet and working-capital discussion.

Also look for:

• Receivable days
• Ageing of receivables
• Bad-debt provisions
• Dependence on government customers
• Large overdue accounts

Fast-growing receivables can make reported revenue look healthier than actual cash generation.

3. One customer controls too much of the business

Search the RHP for:

• “largest customer”
• “top five customers”
• “top ten customers”

If one customer contributes 25%, 40% or even more of total revenue, losing that customer could materially damage the company.

Customer concentration is not automatically bad.

But investors should understand whether the relationship is:

• Contractually protected
• Long term
• Easily replaceable
• dependent on one tender or project

A company with hundreds of customers can still be highly concentrated if most revenue comes from only a few of them.

4. The IPO is mostly an Offer for Sale

Every IPO investor should understand the difference between a Fresh Issue and an Offer for Sale (OFS).

With a fresh issue, the company issues new shares and receives the money.

With an OFS, existing shareholders sell their shares and the company does not receive those proceeds.

So if a ₹3,000 crore IPO contains:

• ₹500 crore fresh issue
• ₹2,500 crore OFS

most of the money is going to selling shareholders, not into the business.

An OFS is not inherently negative. Early investors naturally need exits.

But investors should ask:

Why are existing shareholders selling, and how much are they selling?

5. IPO money is mainly being used to repay debt

Debt repayment can strengthen a balance sheet.

But it can also reveal something about the company's past capital allocation.

Check the Objects of the Issue section.

Ask:

• Why did debt become so high?
• What was the borrowed money used for?
• Did that borrowing generate adequate returns?
• Will debt simply build up again after the IPO?

Debt repayment is far more attractive when it permanently reduces financial risk than when an IPO merely repairs an overleveraged balance sheet.

6. “General corporate purposes” is unusually large

IPO proceeds may include an allocation toward general corporate purposes.

That gives management flexibility.

But investors usually have more visibility when a large portion of the money is earmarked for clearly defined uses such as:

• Building a factory
• Expanding capacity
• Purchasing equipment
• Repaying identified debt
• Funding working capital

The more vague the use of proceeds, the harder it becomes to judge the future return on that capital.

7. Related-party transactions are unusually large

Search the document for Related Party Transactions.

Look for transactions involving:

• Promoters
• Directors
• Promoter-controlled companies
• Subsidiaries
• Family members
• Group entities

Then compare those transactions with total revenue, expenses and assets.

Pay particular attention to:

• Loans to related entities
• Property rented from promoters
• Purchases from promoter entities
• Sales to group companies
• Guarantees
• Asset transfers

Related-party transactions can be completely legitimate.

The concern begins when they become economically significant, unusually complicated or difficult for minority shareholders to understand.

8. Promoter remuneration looks excessive

Find the remuneration paid to promoters and executive directors.

Then compare it with:

• PAT
• Revenue
• Employee costs
• Remuneration at similar companies

If promoters receive a surprisingly large percentage of company profits as salaries, commissions or incentives, minority shareholders should understand why.

Also check whether remuneration continues increasing even when business performance weakens.

9. Promoters or directors have a complicated litigation history

Don't stop after reading the financial statements.

Open the Outstanding Litigation and Material Developments section.

SEBI offer-document disclosures can cover proceedings involving the company, promoters, directors and other relevant parties, including certain regulatory, criminal, tax and material civil matters.

Look for:

• Regulatory actions
• Criminal proceedings
• Tax disputes
• Civil cases
• Environmental proceedings
• Securities-market violations

The existence of litigation does not automatically make a company uninvestable.

The important questions are nature, frequency, financial size and potential impact.

10. Contingent liabilities are large compared with net worth

A liability does not always appear as ordinary debt on the balance sheet.

Companies may also have contingent liabilities arising from areas such as:

• Tax disputes
• Guarantees
• Claims
• Legal cases
• Bank guarantees
• Contractual obligations

Compare contingent liabilities with:

Net worth, annual profit and available cash

A ₹100 crore contingent liability means something very different for a ₹20,000 crore company than for a company with ₹150 crore net worth.

11. Profit suddenly jumps just before the IPO

This deserves extra attention.

Look at at least three financial years rather than only the latest one.

For example:

A sudden profit jump may be completely genuine.

But investigate why it happened.

Possible reasons include:

• Improved operating margins
• Lower finance costs
• One-time income
• Asset sales
• Tax benefits
• Other income
• New subsidiary contribution

You want to know whether the improvement is repeatable.

12. Other income contributes too much to profit

A company can report strong PAT without its core operations improving much.

Check:

Other income ÷ Profit before tax

Other income can include:

• Interest income
• Investment gains
• Asset-sale profits
• Fair-value gains
• Miscellaneous non-operating income

If a significant part of earnings comes from non-core sources, using headline PAT to value the underlying business can be misleading.

13. The IPO valuation requires perfect execution

One of the most useful RHP sections is Basis for Issue Price.

SEBI disclosure requirements provide investors with valuation information such as earnings metrics, return ratios and peer comparisons.

Don't simply ask whether the company is profitable.

Ask:

How much am I being asked to pay for those profits?

Compare the IPO with listed peers using measures relevant to the business:

A fantastic company can still be a poor investment at an extreme valuation.

14. The company has repeatedly changed its business story

Read the History and Certain Corporate Matters and business sections.

Watch for companies that have repeatedly moved from one hot theme to another.

For example:

Textiles → renewable energy → EV → data centres → AI

Business evolution is normal.

But repeated dramatic changes around whatever sector currently attracts investors deserve deeper investigation.

Ask whether:

• The company actually has relevant capabilities
• Revenue already comes from the new business
• Capex has been deployed
• Customers exist
• The announcement is financially meaningful

Never value a company purely on fashionable keywords.

15. The risk-factor section describes the investment case better than the presentation does

This is perhaps the simplest rule.

Companies naturally highlight:

• Market opportunity
• Growth
• Technology
• Expansion
• Competitive advantages

The RHP's Risk Factors section forces investors to look at the opposite side.

SEBI's own offer-document guide advises investors to go through the company's risk factors before making an investment decision.

Don't just count how many risk factors exist. Large RHPs can contain dozens.

Instead identify the five risks capable of seriously damaging revenue, profit, cash flow or the balance sheet.

A simple 20-minute RHP reading method

You do not need to read 500 pages from beginning to end every time.

Start with these sections:

If something unusual appears, then go deeper into the relevant section.

A quick forensic checklist before applying

Before applying to any IPO, try answering these questions:

• Is operating cash flow supporting reported profits?
• Are receivables rising faster than revenue?
• How concentrated are customers?
• How much of the IPO is fresh issue versus OFS?
• Where exactly will fresh capital be used?
• Are related-party transactions significant?
• Are promoters taking unusually high remuneration?
• Is debt manageable?
• Are contingent liabilities material?
• Are there serious regulatory or legal proceedings?
• Did earnings suddenly improve immediately before the IPO?
• Is other income boosting reported profit?
• How does valuation compare with listed peers?
• Are promoters heavily selling?
• Would you still want the business if there were no IPO hype or GMP?

If several answers make you uncomfortable, the RHP may already be giving you the warning.

What readers should watch next

An IPO should be analysed as a business first and a listing event second.

Subscription figures, anchor investors and grey market premiums can change quickly. The quality of cash flows, promoter behaviour, balance-sheet strength and economics of the underlying business matter much longer.

For upcoming IPOs, start with the company's RHP or DRHP available through SEBI and exchange offer-document pages such as NSE.

The objective is not to find a company with zero risks. Such a company does not exist.

The objective is to understand which risks you are being paid to take — and which risks the market may be ignoring.

Disclaimer: This article is for educational and informational purposes only and does not constitute investment advice or an IPO recommendation. Investors should study the complete offer document and consider their own financial circumstances before investing.