CCPS-Compulsory Convertible Preference Shares : Overview

5paisa Research Team

Last Updated: 26 Sep, 2024 11:28 AM IST

Compulsory Convertible Preference Shares
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Businesses used to primarily rely on debt & equity as their sources of funding; debt carries a higher risk for the company, whilst stock carries a higher risk for investors. However, shifting capital requirements & a low tolerance for risk have given rise to new finance techniques, particularly when it comes to start-up funding. Hybrid financial instruments are defined as financial products that incorporate elements of other financial instruments in order to generate profits from these instruments.

What are Preference Shares?

Preference shares are known by their name, which implies that they have precedence over other shares. Compared to equity shares & other types of shares, preference shares have preferential privileges. It is necessary to distinguish these shares from equity shares. In the USA, preference shares are more widely utilized.  Another name for it is preferred stock.

The dividend rate is decided upon at the time these shares are issued. In the case of the company's insolvency or liquidation, repayment of these shares will take priority over equity shares. Furthermore, the assets of promoters are not diminished by CCPS.
 

Types of Preference Shares

Different types of preference shares are offered by companies. The following are the several kinds of preference shares that the corporation offers:

1. Cumulative Preference Shares: Certain dividend arrears are payable to cumulative preference shares. This would only apply to dividends paid out in the prior year, though.

2. Non-cumulative Preference Shares: Dividend payments for non-cumulative preference shares are made without hindrance. Businesses may provide its shareholders with both cumulative & non-cumulative preference shares.

3. Participating Preference Shares: As the name suggests, these are the shares that are entitled to take part in the dividend that is paid to equity shareholders. Upon the company's winding up, preference shareholders are entitled to receive any excess shares after receiving a specified quantity of dividends.

4. Shares Without Participating Preference: These shares are not eligible to receive any kind of participation rights in the dividend that is paid to equity shareholders. Consequently, certain preference share types are not eligible to receive dividend payments.

5.Compulsorily convertible preference shares & convertible preference shares: equity shares may be converted from convertible preference shares. When the shares are being issued, the corporation offers this alternative. Only when specific events pertaining to shares occur inside the firm will these shares be convertible into equity shares. Preference shares that are mandatory to convert into equity shares must be done so. Once converted, shares are no longer a part of the business. The corporation would not grant them any kind of favor.

6. Shareholders are given non-convertible preference shares, which are not convertible into equity shares. Therefore, these share types are redeemable by the corporation. Instead of being equity shares, the shares might be regarded as preference shares.

7. Optionally Convertible Preference Shares: These are shares that the business offers with the only option to convert them into equity shares. All rights attached to the shares would be forfeited upon conversion to equity shares. Preferential rights would therefore be nullified in the event that preference shares were converted to equity shares.

8. Compulsorily Convertible Preference Shares: These shares are subject to mandatory conversion by the issuing business once they are issued. Once offered, the shares would be regarded as company-provided equity shares.
 

What is Compulsory Convertible Preference Shares?

In any growing start-up, Compulsorily Convertible Preference Shares (CCPS) come into play at the fundraising stage. To guarantee that their interests are safeguarded & that they both benefit, investors & start-up owners must choose the best way to join the company. With CCPS, investors may profit from stocks while assuming less risk. Learn everything there is to know about CCPS by reading this blog before you take the next crucial action.

Although most investors find equities investment appealing, there is a risk that returns might be lower. Investing in bonds with fixed yields is usually a safer alternative, but it also means giving up the opportunity to make a tidy profit. With this security, you may benefit from both the stock's profit potential & a fixed return.
 

Benefits of CCPS

Furthermore, without requiring additional cash injection, the CCPS assists startup company founders in managing their ownership during the fundraising stage of new investors. The founders are able to maintain ownership without adding to their holdings since CCPS are anti-dilution securities.

By controlling a sizeable share of the CCPS, which are anti-dilution tools, the founder may oversee their ownership stake in managing the company.

The Reserve Bank of India (RBI) is required to treat the CCPS equally with equity shares. Indian companies may be required to pay through CCPS based on the extent of their involvement in joint ventures. According to the present restrictions on foreign direct investments, one can create or acquire a joint venture abroad by contributing to the venture's share capital by subscription or another method.

Compulsorily Convertible Preference Shares (CCPS) are a type of preference shares that must be converted into equity shares after a specific period or upon the occurrence of particular events. The compulsory convertible preference shares meaning refers to a financial instrument where the holder has no option but to convert the shares into equity, making it different from other types of preference shares where conversion might be optional.
 

Regulation for compulsorily convertible preference shares

The Foreign Exchange Management Rules state that a corporation issuing preference shares must abide by the following rules:

1. No dividend on preference shares may be greater than +3%, which is The State Banking of India's prime lending rate.
2. The rate must be established by taking a resolution of the preferred share price whenever the firm intends to issue equity shares or preference shares.
3. When preferred shares are suggested at the board meeting, this has to be on the agenda.
4-If the company's prime lending rate is 10%, the highest preferred dividend that may be given is 13%. The highest preference dividend that can be given in the event that the prime lending rate rises over 20% is 23%.
5. Preference shares have to be handled like regular shares in accordance with the rules set forth by the Ministry of Finance, the Department of External Affairs, & the Government of India. Equity shares are the common shares that the corporation offers. If these shares are completely convertible, they should be classified as equity shares for the relevant FDI sector limitations.
6. Preference shares are considered external commercial borrowings if they are not convertible into equity shares. Consequently, in the event that the shares are non-convertible, they would be subject to external commercial borrowing regulations.
7. Preference shares in various forms, including non-convertible, partly convertible, & optionally convertible shares, have to be handled as external commercial borrowings. As a result, under this rule, compulsorily converted preference shares may be classified as regular equity shares. Shareholders who receive mandatory convertible preference shares from a firm may convert such shares.
 

Conclusion

Companies that want to raise money can do so by issuing capital instruments. Both inside & outside of India, these instruments are available for purchase. Preference shares that are required to convert are one type of capital instrument available (CCPS). Equity shares may be converted from CCPS. When the shares are being issued, the corporation offers this alternative. Only once specific corporate events take place can these shares be converted to equity shares. Requirement to Convert Preference It is mandatory to convert shares into equity shares.

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Frequently Asked Questions

The shares that are issued with the option to convert into a certain number of equity shares at a later time (as stated in the contract or as previously described) are referred to as Compulsory Convertible Preference Shares (CCPS).

Prior to issuing CCPS, it is necessary to verify if the company's authorized capital is split between equity & preference share capital. If not, you can either reclassify the present structure or increase the authorized capital.

Higher Returns is the primary factor that makes CCPS more appealing to investors than other financial vehicles. Comparing CCPS to more traditional assets like bonds, they frequently yield superior returns due to their combination of fixed income & possible capital gain.

The required conversion feature of CCPS indicates that, on a set date or in response to certain conditions, they will automatically convert into equity shares of the issuing business.

Preference shares frequently automatically convert into ordinary shares during an IPO. This is why convertible preference shares are good—they provide the shareholder the option to convert at any time if it makes sense for them to do so.

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