Top 10 Red Flags to Check in an IPO Before You Apply

By Shuchi, FinanceChecks.com | Published 21 October 2026 | Category: Stock Market | Reading time: about 12 minutes

Sunita, a school teacher in Nagpur, put ₹1.9 lakh into an IPO last year because every message in her family group said the same thing: the grey market premium is huge, apply fast. She did not open the prospectus. It ran to several hundred pages, and it was written in a language she described as “lawyers talking to lawyers”.

She got an allotment, and the stock listed at a small gain. Within a year it had slipped well below the issue price. When she finally read the prospectus out of curiosity, she found what was on page after page. Almost the entire issue was an offer for sale by existing shareholders, so the company itself would receive very little of the money. Most of the fresh money was meant for repaying debt. Her stock had been priced far above comparable listed companies, and operating cash flow had been negative for two of the last three years.

None of this was hidden. It was all in the document. It simply sat there, unread, while the hype did the talking. This guide is meant to save you from Sunita’s experience. I will show you ten red flags you can find in an IPO document, where to look for each, and how to turn them into a simple scorecard you can run before you apply.

Quick Answer

Before you apply to an IPO, check ten things: how much of the issue is an offer for sale rather than fresh capital, what the proceeds will be used for, whether profits are backed by operating cash flow, how the valuation compares with listed peers, the level of debt and pledged shares, the promoters’ track record and litigation, related party transactions, customer or product concentration, auditor remarks and restated numbers, and unusual pre-IPO share issues. Several of these together are a strong reason to skip the issue, however high the grey market premium looks.

About This Guide

This article is written by the editorial desk of FinanceChecks.com, an independent Indian personal finance publication, for retail investors who want to evaluate an IPO themselves instead of relying on tips. It draws on the structure of the offer documents that Indian companies file under SEBI’s ICDR regulations, public information on recent SEBI changes to IPO norms, and widely accepted principles of fundamental analysis. The checks described here are a screening method, not a guarantee of results. A clean checklist does not make an IPO a good investment, and a flag does not always mean a bad one. This article is for education and does not recommend any IPO. SEBI examines offer documents for disclosure, but its observations do not endorse the company or the price.

Where to Find the Information

Every mainboard IPO has a Draft Red Herring Prospectus (DRHP) filed with SEBI, and a final Red Herring Prospectus (RHP) when the issue opens. The RHP is the one to read, because it carries the price band and updated numbers. You can download both from the websites of SEBI, NSE, BSE and the lead managers to the issue.

You do not need to read every page. The sections that matter most are Risk Factors, Objects of the Offer, Basis for Offer Price, the restated financial statements, Outstanding Litigation and Material Developments, and the notes on related party transactions. If you read only these, you will already know more than most applicants.

The Top 10 Red Flags to Check in an IPO

1. Most of the issue is an offer for sale, with little fresh capital

An IPO can have two parts. The fresh issue brings new money into the company. The offer for sale, or OFS, lets existing shareholders sell their shares and keep the money. Neither is wrong by itself, and early investors do deserve an exit. But when the OFS is nearly the whole issue, you are mostly buying shares from people who are leaving.

Here is an illustration. Suppose an IPO is ₹2,000 crore in size, of which ₹300 crore is fresh issue and ₹1,700 crore is OFS. That means 85 percent of the money goes to selling shareholders and only 15 percent reaches the company. If the sellers are private equity funds who have held for several years, it may be an ordinary exit. If the sellers are the promoters themselves, ask why the people who know the business best are selling so much.

Where to look: the front pages of the RHP, which give the split between fresh issue and OFS, and the list of selling shareholders.

2. Vague or weak use of proceeds

Read the Objects of the Offer section closely. Healthy objects are specific, such as building a plant, expanding capacity, or funding working capital for stated growth. Weak objects include large amounts for repaying existing debt, an unnamed acquisition, or a big chunk labelled general corporate purposes. SEBI limits the share of the fresh issue that can be used for unidentified acquisitions and general corporate purposes, so a company that pushes close to those limits is telling you something.

A company that raises money mainly to pay off lenders is not necessarily bad, but you should ask why the debt was needed and whether the business can run without it.

Where to look: Objects of the Offer, the table of proposed deployment of funds, and the section on monitoring of proceeds.

3. Profits without cash flow

Profit is an accounting figure. Cash flow is what actually arrives in the bank. If a company reports growing profits but its operating cash flow is negative or far lower than profit year after year, something is off. It may be selling on generous credit, building up inventory, or booking revenue that has not been collected.

An illustration: a company reports a profit of ₹120 crore, yet operating cash flow is minus ₹40 crore. Receivables have doubled. That gap needs an explanation, and the prospectus rarely volunteers one.

Where to look: the restated cash flow statement and the trend in receivables and inventory over three to five years.

4. An expensive valuation compared with peers

Every RHP has a Basis for Offer Price section that compares the company with listed peers on measures such as price to earnings and return on net worth. Read it critically, because companies choose which peers to show. Then compare it yourself. If the company asks 45 times earnings while listed peers trade at 25 times, and its growth is slower, you are paying a premium for something you cannot see.

Valuation does not decide whether a company is good. It decides how much of the good news is already in the price. An excellent business at an extreme price can still give poor returns.

Where to look: Basis for Offer Price, then your own check of peer ratios on the exchange websites.

5. Heavy debt, pledged shares and large contingent liabilities

Look at the ratio of borrowing to equity, the interest burden against operating profit, and whether any part of the promoters’ shares is pledged to lenders. A pledge can force sales if the share price falls. Contingent liabilities, such as tax disputes and guarantees, sit outside the balance sheet but can become real costs.

A company with high debt can do well when conditions are kind and struggle badly when they turn. For a young listing with a lot to prove, high debt is a red flag unless the business is naturally steady, such as infrastructure with long contracts.

Where to look: Capital structure and debt section, the notes to the financial statements, and the section on promoters’ pledged holdings.

6. Promoter background, shareholding and litigation

Check who the promoters are and what they have done before. Look for regulatory orders, past defaults, criminal cases, or disputes with lenders. Check how much of the company the promoters will hold after the IPO and how much of it is locked in and for how long. Low promoter holding after listing can mean little personal commitment, while a very high pledge can mean financial stress.

Litigation is common in large companies, so do not panic at the existence of cases. What matters is the nature of the case. Cases involving fraud, regulators, or amounts large compared with net worth deserve real attention.

Where to look: the Our Promoters section and the Outstanding Litigation and Material Developments section.

7. Large related party transactions

When a company does a lot of business with firms owned by the promoter family, you cannot be sure prices are fair. Related party transactions are not always wrong. They are a concern when they make up a big share of revenue, when the company lends money to promoter entities, or when the terms seem unusually generous.

Where to look: the related party transactions note in the restated financials. Compare the totals with revenue and with net worth.

8. Dependence on a few customers, one product or one licence

If a handful of customers bring in most of the revenue, the loss of one can hurt the whole business. The same applies to dependence on a single product, a single plant, one state, or one government licence. This is especially common in smaller companies, and the risk factors usually state it plainly, buried in the middle of a long list.

Where to look: Risk Factors, and the business section where customer and product shares are given. Pay attention to the share of the top five customers and the top supplier.

9. Auditor remarks, restated numbers and management churn

The RHP includes restated financial statements, which are the past accounts rearranged on a consistent basis. Look at the auditor’s report for qualifications or emphasis of matter paragraphs, and check how far the restated profit differs from the originally reported profit. A big gap deserves a question. Also look for frequent resignations of auditors, chief financial officers or independent directors in the years before the IPO. Good governance rarely shows a revolving door.

Where to look: the restated financial information, auditor’s report and the section on management and changes in key personnel.

10. Unusual pre-IPO moves and a sudden jump in profit

Be careful when a company sells shares to new investors at a much lower price just before the IPO, issues a lot of bonus shares or splits in the months before filing, or shows a sharp jump in profit only in the final year before listing. None of these is illegal, but together they can suggest a company dressing itself up for the IPO.

Also check the lock-in expiry schedule. Large holders who are free to sell after the lock-in ends can create supply in the market. Read who the anchor investors are, since a book filled mainly with well-known institutional names is a better sign than one filled with unfamiliar names, though it is no guarantee.

Where to look: the capital structure section, which lists share issues in the last several years and their prices, and the lock-in details.

A Red Flag Scorecard You Can Use

Here is a simple way to turn the ten checks into a decision aid. Give each flag a score of 0 if it is clearly fine, 1 if it is a concern, and 2 if it is serious. Add up the numbers.

Flag	Score 0 (fine)	Score 1 (concern)	Score 2 (serious)
1. Offer for sale	Mostly fresh issue, small OFS	OFS is about half the issue	OFS is most of the issue, promoters selling heavily
2. Use of proceeds	Specific projects or capacity expansion	A notable share goes to debt repayment or general purposes	Mostly debt repayment or unnamed acquisitions
3. Cash flow	Operating cash flow broadly tracks profit	Cash flow lags profit in some years	Negative or far below profit for two or more years
4. Valuation	In line with or below listed peers	Moderate premium backed by faster growth	Large premium without faster growth
5. Debt and pledges	Low debt, no pledged shares	Moderate debt or a small pledge	High debt, heavy interest burden or a large pledge
6. Promoters	Clean record, meaningful holding after IPO	Minor cases or low post-IPO holding	Regulatory orders, defaults or serious cases
7. Related parties	Minimal dealings with promoter entities	A noticeable share of revenue or some loans	Large dealings or loans to promoter entities
8. Concentration	Diversified customers, products and regions	Top five customers are a large share	One customer, product or licence drives most revenue
9. Auditor and governance	Clean report, stable management	Emphasis of matter or a few senior exits	Qualified opinion, big restatements or repeated exits
10. Pre-IPO moves	Share issues at sensible prices, steady profit trend	Some bonus issues or placements close to filing	Cheap placements and a sudden last-year profit jump

A total of 0 to 4 suggests a reasonably clean document. A total of 5 to 9 suggests caution and a closer reading. A score of 10 or more is a strong reason to skip the issue. This is my own rule of thumb and not an official or tested rating, so use it as a way to organise your thinking, not as a verdict.

What Does Not Count as a Safety Signal

Some things feel reassuring and are not. Grey market premium is an informal, unregulated quote that reflects trading sentiment and can change quickly. A long list of subscribers or a heavily oversubscribed issue tells you demand was strong, not that the price is fair. A well-known brand tells you the company is famous, not that it is cheap. A SEBI observation letter means the document met disclosure requirements, not that the regulator has judged the business or the price. And an advertisement or an influencer’s video is a marketing message, not analysis.

SME IPOs deserve extra care. They typically have larger minimum application amounts, thinner trading after listing and weaker disclosure at the small end of the market, so the same red flags matter even more there.

Common Mistakes to Avoid

The mistakes I see most often are applying because of the grey market premium, reading only the news article and not the RHP, ignoring cash flow while admiring profit growth, treating a big brand as a safe one, and applying for every IPO in the hope that something will list well. Another is putting too much money in one issue. Even a good IPO can fall after listing, so treat IPO money as high-risk capital and keep your position size modest.

Also remember that missing out is not a loss. There will be another IPO next week, and the discipline of skipping a bad one is worth more than the thrill of a lucky one.

My Take

Having read many offer documents, I believe most of the useful information is on a dozen pages, and most retail investors never reach them. The documents are long on purpose, and the important facts are often neither hidden nor highlighted. They are just there, waiting for someone to look.

I do not think you need to be an expert to avoid the worst IPOs. You need patience and a checklist. Read the use of proceeds, check the cash flow, compare the valuation with listed peers, and see who is selling. If a company does well on those four, you are already ahead of the crowd. If you are unsure, skip it. A bad IPO that you did not apply to costs you nothing.

Frequently Asked Questions

1. What are the biggest red flags in an IPO? The most important ones are a large offer for sale with little fresh capital, vague use of proceeds, profits without matching operating cash flow, a valuation far above listed peers, high debt or pledged shares, promoter problems, large related party dealings, customer concentration, auditor concerns, and unusual pre-IPO share issues.

2. Where can I find the information to check an IPO? In the Red Herring Prospectus, which you can download from the websites of SEBI, NSE, BSE and the lead managers. The most useful sections are Risk Factors, Objects of the Offer, Basis for Offer Price, the restated financials, the litigation section and related party transactions.

3. What is the difference between a fresh issue and an offer for sale? In a fresh issue the company issues new shares and receives the money. In an offer for sale, existing shareholders sell their shares and receive the money, and the company gets nothing. Check the split, because it shows who benefits from the IPO.

4. Is a high grey market premium a good sign? Not necessarily. Grey market premium is an unofficial indicator of trading sentiment that can change quickly and does not reflect the quality or fair price of the business. It also has no bearing on your chance of allotment.

5. How do I know if an IPO is overpriced? Compare its price to earnings and other ratios with listed peers in the same industry, then compare its growth and returns with those peers. If it asks for much higher ratios without clearly better growth or profitability, it may be expensive.

6. Does SEBI approval mean an IPO is safe? No. SEBI reviews the offer document for disclosure requirements and issues observations. This is not an endorsement of the company, its business or the issue price.

7. Why does negative operating cash flow matter in an IPO? It can mean the company’s profits are not turning into cash, perhaps because customers are paying slowly or inventory is piling up. Over several years, weak cash flow can force a company to borrow or raise money repeatedly.

8. Are pledged promoter shares a problem? They can be. If promoters pledge shares to lenders and the stock price falls, lenders may sell the pledged shares, which can push the price down further. A high pledge can also indicate financial stress at the promoter level.

9. Should I avoid every IPO where the promoters are selling shares? Not automatically. Promoters sometimes sell a small portion for personal diversification. The concern arises when they sell most of their holding or when the OFS is nearly the entire issue, because it raises the question of why those who know the company best want to exit.

10. How much should I invest in a single IPO? There is no fixed rule, but because IPOs carry high risk, most investors keep their exposure small relative to their overall portfolio. Invest only money that you can afford to see decline in value, and consider speaking with a SEBI-registered investment adviser for personal advice.

Disclaimer

This article is for general information and education only. It is not investment, tax or legal advice and does not recommend any IPO or security. Offer documents and SEBI rules change, and each issue has its own risks. Read the Red Herring Prospectus carefully and consult a SEBI-registered investment adviser before investing. Investments in securities are subject to market risk, and you can lose some or all of your capital.