As a growing business grows, CCPS (Compulsorily Convertible Preference Shares) are often needed to raise funding. It is vital that the investors as well as the start-up founders find the best way to become a part of the company in order to not only benefit from it but also protect their interests. CCPS offers investors a lower-risk way to make money on stocks. Discover everything you need to know about CCPS in this blog.
While equity participation can be appealing to investors, it does present a risk of lower returns. Investing in bonds with fixed returns is a safe alternative, but it means passing up the chance to make a profit as well. We have a security that offers the advantages of both – stock profit potential as well as a fixed return. Convertible Preference Shares are also known as CCPS.
Fixed-dividend securities are preference shares. Dividend rates are determined when the shares are issued. The repayment of these shares is preferred over equity shares during liquidation or bankruptcy of the company. Further, CCPS do not dilute promoter holdings. Basically, there are four categories:
- Convertible Preference Shares
- Participating Preference Shares
- Cumulative Preference Shares
- Non-cumulative Preference Shares
A convertible preference share can be either Compulsorily Convertible Preference Shares (CCPS) or Optionally Convertible Preference Shares (OCPS).
After a predetermined period, CCPS converts into equity shares of the issuing company and offers fixed income to investors. Also, the conversion terms are decided at the time the certificate is issued.
We offer CCPS in particular to bridge a valuation gap between the founder and the investors whose expectations are generally based on the company’s performance. Investing in these instruments allows investors to participate in the growth of companies while mitigating the risk of companies not achieving their targets. The Company’s promoters will also benefit from issuing CCPS by raising funds without dilution of ownership.
Simplifying it further…
Let’s look at the following example to understand how CCPS works. CCPS was issued by company A at 3.5% and converted into equity after seven years. CCPS holders will be paid an annual dividend of 3.5% of the nominal price, provided there is sufficient profit. Preference Shareholders receive dividends first if the Company cannot pay dividends on both Equity and Preference Shares. Likewise, if a company’s assets cannot repay the share capital brought by equity and preference shares, then priority will be given to the preference shareholders at the time of bankruptcy. The remaining amount, if any, will be distributed to the Equity Shareholders after repayment to the Preference Shareholder. Benefits will continue to be provided to CCPS holders until they convert to equity shares. In the following example, the CCPS will be converted into equity shares at a predetermined ratio at the end of 7 years. It is referred to as the conversion ratio.
Under the guidance of the valuer, a conversion ratio is determined. Obviously, it will depend on the equity value at the time the shares were issued. By converting at a ratio of 1:3, the holder of a CCPS will receive 3 equity shares. The underlying risk of fluctuating share prices is accepted by the investor by accepting the terms of CCPS.
A condition for obtaining CCPS is to determine whether the authorized capital of the company has been classified as Equity and Preference Share Capital. Should this not be the case, you may increase your Authorised Capital or reclassify your current structure. The company can issue Compulsorily Convertible Preference Shares if there is no default in paying dividends or redemption of preference shares. To do this, the company can take the
- The Board will appoint a Registered Valuer to determine the issue price;
- Execute the following actions upon receipt of the Valuation Report: appoint a Board of Directors to approve the draft offer letter and determine the issue price, dividend rate, conversion ratio, and other terms of the issue of Preference Shares; conduct an Extraordinary General Meeting to vote on the terms of the offer;
- Provide 21 days’ notice with an explanation for calling the meeting;
- Pass a Special Resolution at the General Meeting for the approval of the CCPS and the amendment of the Memorandum, if necessary.
- The form MGT-14 for Special Resolution passed by Extraordinary General Meeting must be filed within 30 days upon the resolution’s passage;
- Provide the Offer Letter to the intended recipients;
- Make a deposit by the interested parties;
- Call a Board Meeting to discuss the following:
- Allotment of CCPS to subscribers
- issuing share certificates
- In the 30 days following allotment, file the eform PAS-3.