CCDs are a type of debenture that must be converted into equity shares of the issuing company after a specified period or upon the occurrence of certain events. Unlike optionally convertible debentures, the conversion of CCDs is mandatory, and the terms of conversion, such as ratio and timing, are defined at the time of issue.
In essence, CCDs provide the investor with fixed interest payments like any other debt instrument, but instead of repaying the principal in cash, the company issues shares in the future.
Compulsory Convertible Debentures (CCDs) are one of the sources for raising funds for the corporate sector. CCDs are a type of security that gives holders the option to convert their debentures into a fixed number of equity shares after a specified date.
Raising funds through equity would dilute the stake in the company, whereas the debt will carry a huge rate of interest. Thus, the other alternative is the issuance of Compulsory Convertible debentures [‘CCDs’], which can be converted into equity at a specified time or on the happening of specified events, into equity. CCDs, as the name suggests, are a “debt” instrument which are to be compulsorily converted into equity after a certain period. That is, CCDs are hybrid instruments, being debt at the time of issue along with a certainty to be converted into equity. Hence, Companies go to issue Compulsory Convertible Debentures (CCDs) to maintain control of the company and avoid diluting the shareholding of existing equity shareholders.
Key Features of CCDs
Mandatory Conversion: The defining characteristic of CCDs is that conversion into equity shares is not optional, but compulsory. The terms of this conversion—such as when it happens (maturity period or trigger event) and how many shares are issued (conversion ratio)—are predetermined and outlined in the issue agreement.
Example: A company issues a CCD that will convert into 10 equity shares after 3 years. After that period, the debenture holder will automatically become a shareholder.
Fixed Interest Rate: Until the conversion takes place, CCDs function like regular debt instruments, meaning investors earn fixed periodic interest payments. This is particularly appealing for investors who want a predictable return before becoming equity holders.
- This interest is typically paid annually or semi-annually.
- Post-conversion interest payments stop as the investor becomes a shareholder.
Pre-determined Conversion Ratio: The conversion ratio—i.e., the number of shares the debenture converts into-is either fixed upfront or linked to a formula based on future valuation or performance metrics. This brings clarity and predictability to both the issuer and the investor.
This might also include anti-dilution clauses or valuation caps to protect investor interests.
Dilution of Ownership: Once CCDs convert into equity, the total number of shares outstanding increases, leading to dilution of ownership for existing shareholders. This is particularly important for promoters and early investors who want to retain control.
This is why many founders prefer CCDs with longer conversion windows to delay dilution.
Non-redeemable: Unlike some debentures, which can be redeemed (i.e., bought back by the issuer), CCDs are not repayable in cash. The principal amount is repaid through equity upon conversion, making them fundamentally different from traditional bonds or non-convertible debentures.
Why Do Companies Issue CCDs?
Companies, especially startups and early-stage firms, prefer CCDs for several reasons:
Deferred Dilution: Founders can delay equity dilution, which helps maintain control during the early stages.
Attractive to Investors: Investors receive regular interest, offering a degree of security until conversion.
Regulatory and Tax Advantages: Under Indian law, CCDs are treated as equity for Foreign Direct Investment (FDI) purposes, which can simplify compliance.
Valuation Flexibility: They allow valuation negotiations to be deferred to a future date when the company’s worth might be more clearly established.
Issuance Procedure of CCDs
- Board Approval
- Shareholders’ Approval
- Valuation Report:
A valuation report from a registered valuer or a Chartered Accountant (CA) is required to justify the price at which CCDs will convert into shares.
- Filing with ROC
- File Form MGT-14 (for special resolution) with the Registrar of Companies (ROC) within 30 days of passing the resolution.
- For Private Placement file Form PAS-3 within 15 days of allotment.
- File Form GNL-2 for recording the Debenture Trust Deed, if required.
- Allotment of CCDs
- CCDs must be allotted within 60 days from the date of receiving the application money.
- If not, refund the money within 15 days; else, the company becomes liable to pay interest at 12% p.a.
Compulsory Convertible Debentures are a versatile funding tool, especially suitable for high-growth companies seeking to balance short-term debt obligations with long-term equity financing. When structured properly, CCDs offer a win-win proposition for both investors and issuers by aligning incentives and sharing risks. However, due diligence, legal compliance, and clear contractual terms are essential for their effective use.
