In recent years, investing in an IPO has witnessed an unprecedented popularity in the Indian Capital Markets. Conversations whether an IPO is worth applying for or whether an application has been allotted, has become a tea-time talk with friends and family. For many, applying for an IPO has almost become a trend.

However, driven by the fear of missing out, many investors submit their IPO application without ever reading a Prospectus, the very document which contains critical information of the company, its financials, its business, its management, etc. As a result, many often suffer losses when the scrip underperforms after listing, even in case of well-known brands.

This is precisely why the Risk Factors section become pivotal. It helps investors to understand the key risks which is associated with the Company, enabling them to make informed investment decisions without solely relying on market sentiment or brand recognition. The Risk Factors section is the gap between the hype. It is the section where the company, merchant bankers and its lawyers have to set aside the attractive marketing language and disclose in black and white, what may go wrong with the business.

Below given are some of the key risks which an Investor should look into before hitting the “apply” button:

1. How much debt does the Company have and is it able to pay the debt back on time?

Read about any mention of loans, history of late payments, or amount of pending due to banks. A Company drowning in debt has less room to survive a bad year. Also read about if there are negative cash flows in recent years, that means more money is going out than coming in from normal business even if profit on paper looks fine.

2. Is the company being sued? What are the pending litigations against the Company?

Having pending court cases is not a dealbreaker, but what matters is the nature of litigation, size of the claims and who is involved in those pending litigations. If the promoters or directors are themselves facing serious legal cases, or if there is a pattern of the Company getting penalized by regulators, then that’s worth paying attention to.

For instance, recently Zepto filed the Updated DRHP and it was disclosed in the risk Factors that the Promoters and Founders have received summons from the Enforcement Directorate in relation to a matter with Foreign Exchange Management Act (FEMA). Although it was also disclosed that the Company has responded to the summons and no further communication had been received at the time of filing, still this disclosure created a significant discussion because regulatory proceedings involving Promoters are material information that Investors must evaluate carefully before investing.

3. Does the Company hold all the mandatory licenses and approvals to run the business?

Every business needs a string of licenses, permits and registrations to legally operate, from a factory or environmental clearance to industry-specific approvals, depending on the sector of the business. Disclosure regarding a governmental approval is mandatory whether it is pending, expired or yet to applied for. If a company is operating a facility without a required license, or if a critical approval gets delayed, regulators can order operations to be shut down or scaled back, which directly hits the business of the company and in turn, the investment of the investors.

For instance, in the recent Jio Platform Limited DRHP they have disclosed in the Risk Factors that they do not control “Jio” trademark, this trademark is also used by the other group companies. It has further disclosed that it may be unable to adequately protects its intellectual property rights and could face infringement claims.

4. How dependent is the Company on its promoters or a handful of related entities?

Related party transactions, deals between the Company and businesses owned or controlled by its own promoters, deserve a closer look than most investors give them. They aren’t illegal, and they aren’t unusual, but they tell you how much of the Company’s revenue, supply chain, or cost base flows through people who also happen to be sitting on its board. SEBI treats this as one of the highest-risk disclosure areas precisely because these transactions can be dressed up as “arm’s length” without much to back that up. If the risk factors section is light on detail here, or if a meaningful chunk of purchases or sales run through promoter-linked entities, it’s worth pausing before you subscribe.

The bottom line

The above are few of the instances and are not limited, therefore, the bottom line is the IPO rush is not going away, and there’s nothing wrong with wanting to participate in it. But there is difference between investing and simply applying. Before clicking on the apply button instantaneously, read the Risk Factors chapter for a brief time, it is one of the part of the Prospectus where the Company is legally required to be honest, more than honest than any roadshow, any analyst note or any social media reel.

The difference between an informed investor and a disappointed one is often just that one chapter.

The views expressed in this article are the author’s own and are intended for general informational purposes only. Nothing contained herein constitutes investment advice.