Compulsory Convertible Preference Shares (CCPS)

Compulsory Convertible Preference Shares (CCPS) have become a preferred investment tool for startups, high-net-worth individuals, and private equity (PE) investors. They offer a unique hybrid financial mechanism, blending debt and equity features. CCPS play a pivotal role in bridging valuation gaps, ensuring anti-dilution protection, and providing strategic advantages to both promoters and investors.

Let’s explore CCPS in detail, including their benefits, regulatory framework, and challenges.

What Are CCPS?

CCPS are equity-linked preference shares that automatically convert into equity shares at a predetermined time or upon achieving specific milestones. These instruments are anti-dilution by design and help protect investors and promoters during valuation negotiations.

Key Benefits of CCPS

1. Anti-Dilution for Promoters

Promoters can maintain their equity stake when the company issues shares to new investors at higher valuations. By converting CCPS into equity shares, promoters can increase their stake without infusing fresh capital.

2. Flexibility for PE Investors

PE investors can link the conversion of CCPS to company performance milestones. This ensures the shares are converted only when specific growth targets are met. Additionally, CCPS allow investors to avoid mandatory open offers under SEBI regulations by keeping direct equity stakes below 15%.

3. Strategic Advantage for Startups

For startups, CCPS enable founders to control their equity stake during funding rounds, avoiding dilution while raising capital. This mechanism also resolves valuation disputes by deferring final equity valuation to future funding rounds.

4. Bridging the Valuation Gap

CCPS eliminate the need for exhaustive valuation debates between founders and investors by setting conversion terms linked to future valuations. This approach simplifies negotiations and facilitates smoother funding rounds.

Regulatory Framework for CCPS

1. Companies Act, 2013

Sections 42, 62, and 55 govern the issuance of CCPS under the Companies Act, 2013, alongside rules outlined in Companies (Prospectus and Allotment of Securities) Rules, 2014, and Companies (Share Capital and Debentures) Rules, 2014.

2. FEMA Compliance

Under the Foreign Direct Investment (FDI) Policy, CCPS qualify as equity-linked instruments and can be issued under the automatic route. Conversion terms must align with pricing guidelines and be disclosed upfront.

3. Income Tax Act, 1961

CCPS valuation is subject to Section 56(2)(vii b), which governs the fair market value (FMV) of shares. However, this restriction does not apply when shares are issued to non-residents.

Challenges with CCPS

Complex Structuring: Requires careful negotiation and legal expertise.
Uncertain Capital Structure: Hybrid capital structures can complicate financial reporting.
Limited Control: Preference shareholders may lack voting rights until conversion.
Exit Restrictions: Some CCPS agreements limit early exits for investors.

International Practices for CCPS

USA: Known as preferred stock, CCPS are widely used in startups. The 409A valuations ensure compliance with tax regulations.
Germany: Preferred stock is convertible into common stock with the approval of both common and preferred shareholders.

Why Choose Lal Ghai & Associates?

Navigating the complexities of CCPS issuance requires expert guidance. At Lal Ghai & Associates, we offer:

Comprehensive legal and regulatory advice.
Assistance with CCPS structuring and compliance.
Support with Companies Act, FEMA, and Income Tax regulations.

📩 Email: info@lgassociates.org
📞 Contact Us: +91-9463640466

FAQs About CCPS

1. What makes CCPS different from equity shares?

CCPS are preference shares that convert into equity shares at a predetermined time or condition, offering anti-dilution and valuation flexibility.

2. Are CCPS taxable in India?

Yes, CCPS are subject to taxation under Section 56(2)(vii b) of the Income Tax Act, 1961. Non-residents, however, are exempt from certain pricing restrictions.

3. Can CCPS be issued under the FDI policy?

Yes, CCPS qualify under the automatic route of FDI, provided compliance with sectoral caps and pricing guidelines is ensured.

Secure your company’s financial future with the right CCPS strategy. Contact Lal Ghai & Associates for expert guidance today!