Group Companies in a DRHP: How Issuers Pick Them and What Investors Should Check

Every draft prospectus has a chapter that most retail investors scroll straight past: the one on group companies in a DRHP. It looks like a dull list of private limited names. It isn’t. That chapter tells you which other businesses sit close enough to the issuer to share its customers, its money and sometimes its problems. If you want to know where cash could leak out of the company you’re about to buy, this is one of the first places to look.

SEBI’s rulebook decides what goes into that chapter. The interesting part is that it leaves a fair bit to the issuer’s own board. Let’s go through what the rule says, what has to be disclosed, and how we’d read it with a few made-up examples.

What counts as group companies in a DRHP

The definition is in Regulation 2(1)(t) of the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018, the ICDR Regulations. Everything quoted below is from that text as notified in September 2018. SEBI amends these regulations from time to time, and the disclosure format may have changed since, so check the latest consolidated version on SEBI’s site before relying on any single clause.

Under that clause, group companies include companies, other than the promoters and subsidiaries, that fall into one of two buckets:

• companies with which there were related party transactions during the period for which financial information is disclosed in the offer document, as covered under the applicable accounting standards; and
• other companies the issuer’s board considers material.

Read that twice, because it’s quite different from the promoter group. The promoter group is drawn by fixed tests: a list of relatives and 20% shareholding thresholds. Group companies are drawn by business dealings. If the issuer bought from, sold to, borrowed from or lent to a company during the period covered by the financial information in the offer document, and that company is a related party under the accounting standards, it lands in the list. Shareholding alone doesn’t decide it.

The second bucket is where judgement comes in. The board can add any other company it considers material. So when you read the chapter, check whether the offer document explains what yardstick the board used to decide materiality.

The promoter group is about family and shareholding. Group companies are about money actually changing hands with the issuer. Both lists matter, for different reasons.

Who is left out, and why that matters

The definition explicitly excludes the promoters and the subsidiaries. That doesn’t mean they escape disclosure; the offer document covers them in their own sections. It just means the group companies chapter is about the other businesses in the orbit: the sister concern that supplies raw material, the family firm that leases the factory land, the trading company that buys the output.

Those sister concerns are where conflicts of interest tend to live. A subsidiary’s numbers are consolidated into the issuer’s accounts. A group company’s numbers are not. If profit is quietly being shifted, it’s usually shifted towards an entity whose accounts you don’t normally see.

What the ICDR text asks the issuer to disclose

Schedule VI of the 2018 regulations has a section titled “Information with respect to group companies”. In the version as notified, it asked for the following, for the last three years and based on audited statements, along with significant auditor notes, for issuers other than government companies, statutory authorities or special purpose vehicles set up by them:

• date of incorporation and nature of activities;
• equity capital and reserves (excluding revaluation reserve);
• sales and profit after tax;
• earnings per share and diluted EPS;
• net asset value;
• for listed group companies, the highest and lowest share price in the preceding six months;
• where a company made a public or rights issue in the preceding three years, the issue price and the current market price.

There’s a cap on how many companies need full financials. If there are more than five listed group companies, the information can be limited to the five largest by market capitalisation, measured one month before the draft offer document is filed (the text has a separate reference date for fast track issues). If there are fewer than five listed ones, all the listed ones are covered plus the largest unlisted ones by turnover, so that the total doesn’t exceed five. If none is listed, it’s the five largest unlisted group companies by turnover.

The same section then asks for things that matter more than the numbers:

• pending litigation involving a group company that has a material impact on the issuer;
• significant adverse factors, in particular whether a group company has become sick under the Sick Industrial Companies (Special Provisions) Act, 1995 or is under winding up or insolvency proceedings, and whether it made a loss in the immediately preceding year, with profit or loss figures for the preceding three years if so;
• group companies that went defunct and applied to the Registrar of Companies to be struck off in the five years before the draft offer document was filed, with the reasons and any pending litigation;
• “common pursuits”: where group companies and the issuer are in similar lines of business, the reasons and justification, and the conflict of interest situations;
• related business transactions within the group and their significance to the issuer’s financial performance;
• where a group company has business interests in the issuer, the amount of business it has or proposes to have with the issuer, or a clear negative statement if there is none.

Where else group companies show up in the offer document

The chapter isn’t the only place. The same 2018 text pulls group companies into several other sections, and these are the cross-references we find most useful.

Risk factors. The schedule lists, among the risks to be disclosed, any refusal of listing of securities of the issuer or its subsidiaries or group companies in the last ten years by any stock exchange in India or abroad, and any failure by them to meet listing requirements, with details of penalties such as trading suspensions. It also lists a large number of pending investor grievances against the issuer, its listed subsidiaries and its top five listed group companies by market capitalisation.

Objects of the issue. The issuer has to disclose details of all material existing or anticipated transactions with promoters, promoter group, directors, key managerial personnel and group companies in relation to the use of issue proceeds or project cost. If part of the money is to be lent to a group company, the loan details have to be given.

Interests. The offer document must give full particulars of any interest of the promoters, directors or group companies in the promotion of the issuer, or in property the issuer acquired in the preceding three years or proposes to acquire.

Investor complaints. The issuer discloses the number of investor complaints pending on the filing date for its five largest listed group companies by market capitalisation.

Convertible debt. Regulation 12 bars an issuer from issuing convertible debt instruments to finance, lend to or buy shares of anyone in the promoter group or group companies, unless they are fully convertible with a conversion period of less than eighteen months from issue.

If IPO money is headed to a group company, through a loan, a land deal or a supply contract, the offer document has to say so. The trick is reading the chapters together.

Worked examples: reading the chapter

These are hypothetical. No real company is described; the point is to practise the reading.

Example 1: the supplier next door

Say Sahyadri Textiles files a DRHP. The financial information in it covers three years. During those years it bought yarn from Sahyadri Spinners Pvt Ltd, which is owned by the promoter’s brother, and that company is disclosed as a related party under the accounting standards. Spinners is not a subsidiary and not a promoter, so it falls within the group companies definition through the related party transaction test.

Now suppose the related party note shows purchases from Spinners of ₹40 crore, ₹55 crore and ₹70 crore across the three years, while Textiles’ total raw material cost is ₹200 crore, ₹220 crore and ₹230 crore. A quick division gives us 20%, 25% and about 30.4% of raw material cost coming from one family-owned supplier, and rising. That’s the question to take into the common pursuits and related business transactions disclosures: are the prices at arm’s length, and what happens if the relationship changes after listing?

Example 2: the five-company cut-off

Kesar Foods has eight group companies. Three are listed, with market capitalisations of ₹900 crore, ₹450 crore and ₹120 crore a month before filing. Five are unlisted, with turnovers of ₹300 crore, ₹180 crore, ₹60 crore, ₹25 crore and ₹5 crore.

Under the 2018 schedule, since there are fewer than five listed group companies, all three listed ones get full financials, plus the two largest unlisted ones by turnover (₹300 crore and ₹180 crore), bringing the total to five. The other three unlisted companies don’t get the full financial table. They still count for litigation, adverse factors and defunct-company disclosures where those apply, so skim the whole chapter rather than just the tables.

Example 3: the loss-maker in the family

Suppose one of Kesar’s unlisted group companies made a loss last year and is in insolvency proceedings. The adverse factors disclosure should flag both, with three years of profit or loss figures. On its own that isn’t a reason to skip the IPO. But if the objects section also shows a loan from IPO proceeds to that same company, the picture changes completely. Money raised from the public would be going into a business that’s already in trouble.

A short checklist for the group companies chapter

1. Count the list and read the materiality policy. A handful of names with a clear policy is reassuring. A long list with a vague “considered material by the board” line deserves more digging.
2. Match it with the related party note. The financial information in the offer document carries a related party note. Big, growing numbers with one group company tell you where the dependence is.
3. Read common pursuits closely. If a group company runs the same business, ask who gets the better contracts. The offer document has to state the conflict of interest situations.
4. Search the objects section for group company names. Loans, land purchases or payments to group companies out of IPO proceeds are worth a hard look.
5. Check litigation and defunct companies. Material cases and struck-off companies tell you something about how the wider group is run.
6. For listed group companies, look at the price range and pending complaints. Weak share prices and piles of unresolved complaints in sister listed companies are a signal about governance across the group.

Do this reading on the DRHP, and then check the same chapter again in the red herring prospectus in case anything has been added or changed. For the wider framework on judging a new issue, our guide to IPO investing in India is the place to start.

We’d put it simply. The promoter’s name gets you interested in an IPO. The group companies chapter tells you whether the promoter’s other businesses are going to be leaning on this one.

Sources

• SEBI: Issue of Capital and Disclosure Requirements Regulations, 2018 (as notified September 2018), Regulation 2(1)(t), Regulation 12 and Schedule VI

Disclaimer: This article is for education only and is not investment advice. All companies, figures and transactions in the worked examples are hypothetical. Regulations change; refer to the latest SEBI text and consult a SEBI-registered investment adviser before making any investment decision.