Compulsory Convertible Preference Shares (CCPS) in India are a type of hybrid security that combines features of both debt and equity. It is the most favorable means for investors and most commonly used in the early stage of any start-up. They are issued as preference shares with a predetermined conversion price and a fixed maturity date, at which point they will automatically convert into common shares.
CCPS are particularly offered to fill the gap between the valuation expectations of the founder and the investors that are generally linked to the performance of the Company. It is often used by companies as a means of raising capital, as they offer a low-cost alternative to issuing debt and a more attractive option than issuing new equity, as they do not dilute existing shareholder holdings.
Investors prefer CCPS more as in CCPS they receive a fixed rate of return in the form of dividends, and in case of liquidation or insolvency, the shareholders get the priority per the waterfall mechanism as stated under the provisions of Section 53 of Insolvency and Bankruptcy Code, 2016 which gives the holders a prior claim over the assets of the venture, also the potential for capital appreciation if the market price of the underlying common shares increases.
Compliance with Companies Act, 2013: In India, CCPS are governed and regulated by Section 42, 62 and 55 of the Companies Act, 2013.
Compliance with FEMA Act: Foreign investments are permitted where the compliances relating to FEMA and FDI policy must be adhered to. Companies must comply with these regulations in order to issue CCPS, which include disclosure requirements and investor protection measures.
Compliance with SEBI Regulations: The company must comply with SEBI regulations, including the SEBI (Issue and Listing of Debt Securities) Regulations, 2008 and the SEBI (Issue and Listing of Non-Convertible Redeemable Preference Shares) Regulations, 2013.
Higher Returns: CCPS typically offer higher returns compared to other instruments such as bonds, as they offer a mix of fixed income and potential for capital appreciation.
Convertibility: CCPS can be converted into equity shares at a predetermined price, giving investors exposure to the potential growth of a company.
Priority in Receiving Dividends: CCPS holders have priority over common stockholders in receiving dividends, which can provide a stable income stream.
Reduced Risk: CCPS are generally considered a low-risk investment, as they have priority over common stock in receiving dividends and in the event of liquidation.
Performance: CCPS conversion is linked with the performance of the company and helps the investors to balance any disparity in the valuation expectation of the venture, as the general valuation process which renders inefficient in case of start- ups due to the absence of any profit and loss account.
Tax Benefits: In some countries, the dividend income from CCPS may be taxed at a lower rate compared to other instruments. Also, the compliances under Income Tax Act 1961 shall be adhered to.
Issuing Compulsory Convertible Preference Shares (CCPS) in India is regulated by the Companies Act, 2013 and the Securities and Exchange Board of India (SEBI) regulations. Here are the steps for issuing CCPS under the Companies Act, 2013:
Check the Authorised Capital of the company is classified in Equity and Preference Share Capital. If not, either increase the Authorised Capital or go for reclassification of the current structure.
No default in payment of dividend due on Preference Shares or redemption of preference shares, then the company can proceed for issue of CCPS (Compulsorily Convertible Preference Shares) in the following steps:
Board Meeting: The board of directors of the issuing company must approve the issuance of CCPS and authorize the issuance of a prospectus or offer document. Post board approval, consider approval and appoint a registered valuer in order to determine the issue price.
Another Board meeting Once the valuation report is ready, conduct a meeting for approve the draft of offer letter, issue price, dividend rate, conversion ratio and other terms and conditions for issuance subject to approval of the shareholders in the Extra ordinary General Meeting (EGM)
Notice of EGM: issue the notice to the members, directors, auditors and whosoever concerned at least twenty-one days before with Explanatory Statement for calling and EGM.
EGM: Conduct the EGM as per the notice date and venue decided to pass the Special Resolution for approval of issue of CCPS and alter the Memorandum or Articles of Association, if required
Filing MGT-14: The company must file a copy of the prospectus or offer document, special resolution passed in the EGM with the Registrar of Companies (ROC) in form MGT-14 within 30 days of EGM to obtain the ROC's approval
Offer to Public: The company must offer the CCPS to the public through a prospectus or offer document, which must be approved by SEBI and comply with the disclosure requirements set forth by the Companies Act, 2013
Board meeting for Allotment of CCPS: Once the offer is completed, subscription money by the parties is received, the company must allot the CCPS to the investors and issuance of share certificates.
Filing PAS-3: Filing of e-form PAS-3 with the Registrar of Companies (ROC) entailing the details of the CCPS allotment within 30 days of the allotment to obtain the ROC's approval.
Listing: The company may choose to list the CCPS on a stock exchange, which will provide increased liquidity and marketability to the CCPS.
However, the preference for CCPS can also depend on individual investor's risk tolerance, investment objectives, and other factors. Additionally, it is important for investors to carefully consider the terms and conditions of CCPS before investing, as the convertibility feature can also result in dilution of equity holdings.
It is important for investors to carefully consider the terms and conditions of CCPS before investing, as the convertibility feature can result in dilution of equity holdings if the conversion price is below the current market price of the underlying shares. Additionally, the performance of CCPS is linked to the performance of the underlying company, so investors should assess the financial and operational health of the company before investing in CCPS.
It is important for companies to seek the advice of legal and financial professionals to ensure compliance with all applicable regulations and to structure the issuance of CCPS in a manner that is in the best interest of the company and its shareholders.