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In the past, businesses have mostly depended on debt and equity as their primary sources of finance; debt implies more risk for the organization, while stock involves more risk for investors. However, new funding strategies have emerged due to changing capital demands and low-risk tolerance, especially in the context of start-up financing. Financial products that combine the features of other financial instruments to produce profits derived from these instruments are categorized as hybrid financial instruments.
Compulsorily Convertible Preference Shares
Compulsorily Convertible Preference Shares (CCPS) enter the scene during the fundraising phase in each expanding start-up. Finding the appropriate method to join the firm is essential for investors and start-up owners to ensure that their interests are protected and that they both profit from it. CCPS allows investors to benefit from equities at a reduced risk. Before you take the next important steps, read this blog to learn everything there is to know about CCPS.
While investing in equity generally appeals to investors, there is a danger that returns may be lower. A typical safer option is to invest in bonds with guaranteed yields, but doing so also means passing up the chance to make a tidy profit. This security gives you the best of both worlds: a set return and the stock’s potential for profit.
What are Preference Shares?
When these shares are issued, the dividend rate is determined. Repaying these shares takes precedence over equity shares in the event of the company’s insolvency or liquidation. Additionally, CCPS does not lessen promoters’ holdings. There are four primary classifications:
- Convertible Preference Shares
- Participating Preference Shares
- Cumulative Preference Shares
- Non-cumulative Preference Shares
CCPS: how do investors of private equity (pe) benefit?
Investors who acquire CCPS may choose to link the conversion date to the business’s success. This implies that only when the business achieves its projected expansion may the investor choose to convert CCPS to stock. If these goals are not met, investors can increase their investment in the business.
What benefits do ccps have for startups?
Additionally, the CCPS helps the founders of startup companies manage their ownership during the fundraising stage of new investors without requiring fresh capital infusion. The fact that CCPS are anti-dilution securities allows the founders to manage their ownership without acquiring any more lands.
The founder may supervise their equity interest to run the business by owning a sizable portion of the CCPS, which are also anti-dilution instruments.
The CCPS are to be considered on the same footing as equity shares, due by the Reserve Bank of India (RBI). Indian businesses can make financial obligations through CCPS, depending on their exposure to joint ventures. The current Overseas Direct Investments regulations envision establishing or purchasing a joint venture overseas by investing in the venture’s share capital through subscription or other means.
What Is NBFC’s Anti-Dilution In CCPS?
The Compulsorily Convertible Preference Shares (CCPS) allow the promoters of the business to retain their equity holding if new investors are issued equity shares. When a new investor delivers money at a higher value, the promoters may exchange the CCPS they took at the time of the lower share price. This allows the promoters to expand their shareholding without incurring further costs.
What are the advantages of Compulsorily Convertible Preference Shares (CCPS)?
Shareholders in private equity (PE) also profit from CCPS. Investors can connect with the firm’s achievements at the time of conversion. These essentially indicate that the shares won’t be convertible until the NBFC reaches the desired rate of development. The PE company maintains the right to expand its shareholding if the aim is unmet. By rules set forth by the capital market regulator, an open offer is triggered if a listed firm is acquired for 15% or more. Similarly, a PE firm may accept 14.9% of direct equity and the remaining amount in the form of securities, which may convert to equity within 18 months. The companies can potentially get out of the one-year lock-in term for PE investments this way.
How Does CCPS Benefit Emerging Businesses?
Additionally, the CCPS helps startup company founders manage their share in new investors throughout the fundraising stage without raising additional capital. Since CCPS are anti-dilution instruments, the founders can oversee their equity without contributing more capital. The founders may also manage their equity share to run the firm by keeping sizable ownership.
How Does CCPS Aid In Preventing Valuation Gaps?
The CCPSs prevent the value discrepancy between investors and the entrepreneur. In theory, various techniques are used to equalize the equity’s share value. The “relative valuation” approach is the most often used way of computation. The discounted cash flow, or DCF, approach is another valuation technique used. The issue with this approach is that valuation involves too many assumptions. Here, a projection spanning at least five years is required, and estimates must be made to determine the relevant capital cost and terminal value. Therefore, if there is any disagreement with the promoter over investing through convertible preference shares—which set the angel’s price—that is a straightforward method to avoid a value dispute.
Regulatory framework for the issue of ccps
One of the company’s strategic decisions, issuing CCPS securities, is essential to managing the promoters’ equity share. Three main laws must be complied with to issue CCPS:
Companies Act, 2013: Sections 42, 62, and 55 of the Companies Act of 2013, in conjunction with the Companies Rules of 2014 and the Companies Rules of 2014, are the main laws governing the issuance of CCPS.
Foreign Exchange Management Act, 1999: Because the CCPS is an equity-linked instrument, overseas investors may subscribe automatically under the Overseas Direct Investment Policy, subject to price rules. The terms and circ*mstances for the conversion shall be decided upon when the aforementioned instruments are issued.
Income Tax Act, 1961: Section 56 (2) (viib) of the Income Tax Act of 1961 will apply to the assessment of CCPS. This section clarifies that any consideration obtained by an unlisted company—one in which the public does not have a substantial interest—for issuing shares that surpass their face value will be subject to income tax under the heading “income from other sources.” However, the aforementioned pricing limitation is not applicable when shares are offered to a non-resident individual.
Alternatives to CCPS
Although CCPS is an excellent way to diversify your investments, it may also be difficult to use. For this reason, you should consider alternate choices that provide comparable advantages without the hassles.
These are the following:
Convertible Compulsory (CPC): A convertible security, as is the case of CPCs, can turn into a bond or stock.They are, as such, attractive to investors seeking to expand the scope of their investments.
Optionally Convertible Performance Shares (OCP): With OCPs, the management of capital is made available as firms with reputable records of operation are invested.However, unlike other mutual funds, your proceeds may not be determined by the number of shares you own from all the assets that are under ownership.
Hybrid Funds (HYB): Hybrid funds (HYBs) make use of the characteristics associated with ETF and mutual funds.They bridge the speed of electric vehicles with normal automobile options in terms of engine economy similar to hybrid autos.
RBI Guidelines
It is required that the provided document for private placement be submitted no later than six months from the day of the Board Resolution that permits the certificate to be issued. The names and positions of the authorities designated as having the authority to issue the offer documentation must appear in the offer document. All information on the reason for raising the resources must be included in the Board Resolution and the proposal.
- “For Private Circulation Only” must be typed or written on the offer paper. The offer document should include general information, such as all of the locations for the NBFC’s corporate office, the date the issue opened or closed, etc.
- The NBFC must issue debentures to allocate cash on its balance sheet, not to support the resource requirements of group entities, parent businesses, or associates.
- No more than 49 investors chosen by the NBFC will be able to participate in any one of the NBFCs’ private placements.
- A single investor’s minimum subscription value will be Rs. 25 lakh, with subsequent multiples of Rs. 10 lakh.
- An NBFC will not make loan extensions secured by its debentures; there must be a minimum six-month interval between the two transactions.
- The provisions of the aforementioned guidelines take precedence over other instructions in cases where they conflict with one another.
- All other orders about private investments stay unaffected.
Conclusion
The NBFCs are responsible for ensuring that all issued debentures, particularly the short-term NCDs, remain safe at all times. Therefore, if at any point throughout the issuance process, the security cover is deemed inadequate or nonexistent, the issue will be placed under escrow till security is produced, which should ideally occur no later than one month from the date of issuance. This page discusses the many legal compliances that go into creating the CCPS. These days, nevertheless, CCPSs are influencing the company, shareholders, and founders’ strategic decisions in a big way.
