Introduction
While there is always the risk of losing money when buying stocks, avoiding them altogether means missing out on the opportunity to make good profits. However, there is one type of security that may help some investors solve this problem- compulsory convertible preference shares (CCPS), which provide a guaranteed rate of return as well as the opportunity for capital appreciation.
What are Compulsory Convertible Preference Shares (CCPS)?
CCPS are corporate fixed-income securities that the investor can choose to turn into a particular number of shares of the company’s common stock after a set period or on a specific date. The fixed-income component provides a steady income stream as well as some capital protection. The option to convert these securities into stock, allows the investor to profit from a rise in the share price.
Convertibles are particularly attractive to those investors who wish to participate in the rise of the growth of companies while also protecting themselves from a price decrease if the stocks do not live up to the expectations.
How CCPS benefit the Private Equity (PE) investors?
Investors who obtain CCPS, have the option of tying the conversion date to the company’s performance. This means that the investor may decide to convert CCPS to equity only after the company achieves the expected growth. Investors will be able to raise their stake in the company if these targets are not achieved.
How does CCPS benefit the start-ups?
The CCPS also assists the start-up company founders in controlling their stake at the funding stage of new investors without the infusion of new funds. The founders can manage their stake without adding any further lands because CCPS are also anti-dilution securities.
Because the CCPS are also anti-dilution securities, the founder can manage their equity stake to run the company by holding a substantial stake in the company.
Regulatory Framework for issue of CCPS
The issue of CCPS securities is a strategic decision of the company and plays a crucial role in controlling the equity stake of the promoters of the company. Issue of CCPS involves compliance of three major laws:
- Companies Act, 2013
The issue of CCPS are primarily governed by provisions of Section 42, 62 and 55 of the Companies Act, 2013 read with Companies (Prospectus and Allotment of Securities) Rules, 2014 and Companies (Share Capital and Debentures) Rules, 2014.
2. Foreign Exchange Management Act, 1999
The CCPS are equity linked instrument hence foreign investors may subscribe via the Foreign Direct Investment Policy under automatic route subject to pricing guidelines. The conversion terms and conditions will be determined at the time of issue of said instruments.
3. Income Tax Act, 1961
The valuation of CCPS will be governed by the provisions of Section 56 (2) (viib) of the Income Tax Act of 1961, which states that if an unlisted company, not being one in which the public has a substantial interest, receives any consideration for the issue of shares that exceeds the face value of such shares, the aggregate consideration received for such shares shall be chargeable to income-tax under the head income from other sources. However, when shares are issued to a non-resident person, the aforesaid pricing restriction does not apply.
The content of this article is intended to provide general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
References
Private equity firms prefer convertibles to direct equity, Mint, available at https://www.livemint.com/Money/rkcStm18Wex1Z8yPvnAFuO/Private-equity-firms-prefer-convertibles-to-direct-equity.html last seen on 15/07/2021
Ben McClure, Understanding Convertible Preferred Shares, Investopedia, https://www.investopedia.com/articles/stocks/05/052705.asp last seen on 15/07/2021
Compulsory Convertible Preference Shares, Journals of India, https://journalsofindia.com/compulsorily-convertible-preference-shares/ last seen on 15/07/2021
