Risk factors that are often overlooked in IPO papers

With stock markets hovering around record high levels, the IPO season is ruling strong. For an investor, the red herring prospectus provides comprehensive information to assess the risk of investing in an IPO-bound company. Here are the key governance risk factors that are so commonly seen in the RHP that they are most likely overlooked. Concerns related to the way the business is undertaken tend to impact the company much more severely than the factors that are endemic to the business or the industry.

Promoters in similar business or company having related party transactions

Company’s promoters being in businesses similar to the company’s business and having interests in certain companies may result in potential conflict of interest. Likewise, a very high proportion of related party transactions relative to the total revenues is a red flag for investors. For instance, Cello World had reported in its DRHP the related party transactions amounting 53% of its FY23 revenues.

Ongoing investigation or civil or criminal litigation, especially in jurisdictions outside India

An ongoing investigation by the income- tax department, Sebi or an industry regulator, especially in jurisdictions outside India, is to be probed to know the severity and implications for the company. For instance, although Emcure Pharma has de-merged its US operations, it has ongoing civil proceedings in the US, including class-action antitrust cases and complaints filed by the US state attorneys-general, that could result in significant losses and liabilities.

Delay in payment of statutory dues

Delay in payment of statutory dues such as taxes, employee provident funds, etc., can be a sign of cash flow issues and poor management practices. For instance, there have been delays in payment of statutory dues in case of Allied Blenders on account of delayed collections from corporation markets, which resulted in interest to be paid on delayed payment of dues. For the nine months ended December 2023, the company paid an interest of ₹31 crore.Records related to company not traceable

Prima facie, it may seem to be an innocuous aspect of old record-keeping for a company, but records related to corporate filings and forms not being traceable is a sign of gaps in company’s documentation and could impact the perceived reliability about the company’s governance.

These risk factors are broad red flags for long-term investors. These may not necessarily manifest into negative implication for a company. But they serve to be a broad gauge of the level of corporate governance maintained during the pre-IPO stage.