In the world of corporate finance, companies often require capital to expand operations, develop products, or support working capital. One popular method of raising funds is through the issuance of debentures. Among the various types, Compulsorily Convertible Debentures (CCDs) stand out as a hybrid instrument that offers both debt and equity features. CCDs are particularly attractive to investors and businesses alike because they provide a fixed return during the debt phase and are later converted into equity shares. To ensure compliance and transparency, the procedure for issuing Compulsorily Convertible Debentures must follow specific steps governed by corporate laws, regulatory bodies, and internal company protocols.
Understanding Compulsorily Convertible Debentures (CCDs)
What Are CCDs?
Compulsorily Convertible Debentures are a type of debt instrument issued by a company that mandatorily converts into equity shares after a specified period. Unlike optionally convertible debentures, the conversion of CCDs into shares is not at the discretion of the holder but is a mandatory condition agreed upon at the time of issuance.
Key Features of CCDs
- They carry a fixed interest rate until conversion.
- They are non-repayable in cash but convert into equity shares.
- Conversion terms, including the time frame and ratio, are pre-determined.
- They do not dilute shareholding immediately but do so upon conversion.
Step-by-Step Procedure for Issuing CCDs
1. Board Resolution
The process begins with the approval of the Board of Directors. A board meeting must be convened to pass a resolution approving the proposal to issue Compulsorily Convertible Debentures. The resolution should specify the total amount to be raised, the number of debentures, face value, interest rate, conversion ratio, and tenure.
2. Shareholders’ Approval
As CCDs ultimately convert into equity shares, they can affect the shareholding structure of the company. Therefore, issuing CCDs requires shareholders’ approval through a special resolution passed in a general meeting. This resolution should clearly outline the detailed terms and conditions of the CCD issuance.
3. Valuation Report from Registered Valuer
Before the issuance, a valuation report from a registered valuer or merchant banker is required. This report determines the fair value of the company and helps set a conversion price that aligns with market standards. This is especially crucial for private placements and to avoid dilution at an unfair value.
4. Drafting of Offer Letter and Agreements
An offer letter or private placement memorandum must be prepared containing all relevant details such as the nature of debentures, pricing, conversion mechanism, and timelines. Additionally, if CCDs are being issued to specific investors, a debenture subscription agreement or term sheet must be executed with clear terms and conditions.
5. Filing with the Registrar of Companies (RoC)
Several filings must be made with the Registrar of Companies:
- Form MGT-14 for special resolution approval within 30 days of the general meeting.
- Form PAS-4 for the private placement offer letter.
- Form PAS-3 for allotment of CCDs within 15 days from the date of allotment.
All these filings must comply with the Companies Act, 2013 and associated rules in jurisdictions such as India.
6. Opening of Separate Bank Account
The company must open a separate bank account to receive money from the investors subscribing to CCDs. This account should be used exclusively for the allotment process, and the funds must be used only after the CCDs have been formally allotted.
7. Allotment of CCDs
Once the subscription amount is received, the company must allot the Compulsorily Convertible Debentures to the respective investors. This allotment should be recorded in the company’s records and share register.
8. Issuance of Debenture Certificates
Following allotment, the company must issue debenture certificates to the investors within 6 months from the date of allotment. The certificates should contain the terms of conversion and other important information.
9. Compliance with RBI and SEBI (If Applicable)
If the issuance involves foreign investors or public companies, additional compliance may be needed. For foreign investment, the company must follow the Foreign Exchange Management Act (FEMA) and file Form FC-GPR with the Reserve Bank of India. If the company is listed, SEBI’s regulations on disclosure and listing must also be followed.
10. Conversion of CCDs into Equity Shares
At the end of the specified tenure, the CCDs must be converted into equity shares. This is a mandatory process and should follow the conversion terms agreed upon during issuance. Post-conversion, the company should:
- Update the Register of Members with the new shareholders.
- Issue share certificates or credit shares into the Demat accounts of investors.
- File the necessary forms with the RoC to reflect the change in share capital structure.
Advantages of Issuing CCDs
For Companies
- Allows raising of capital without immediate dilution of equity.
- Provides structured funding for long-term growth.
- Attracts strategic investors who want equity in the future.
For Investors
- Provides fixed returns during the debt phase.
- Offers future equity participation with potential for capital appreciation.
- Lower risk during the initial stages of investment.
Common Challenges and Considerations
Regulatory Scrutiny
Issuing CCDs can attract scrutiny from regulators, especially when involving foreign entities. Any deviation from approved terms can lead to penalties or cancellation of the issuance.
Conversion Complications
If not clearly defined, conversion terms can lead to disputes or complications. Companies must ensure that conversion ratios, dates, and pricing are transparent and in line with applicable regulations.
Impact on Shareholding
Upon conversion, CCDs increase the number of equity shares, potentially diluting the shareholding of existing investors. Founders and management should plan this dilution strategically.
The procedure for issue of Compulsorily Convertible Debentures involves a series of carefully regulated steps, from board approval to conversion into equity shares. It is a powerful financing tool that bridges debt and equity, offering benefits to both issuers and investors. By ensuring proper compliance, transparent agreements, and regulatory filings, companies can leverage CCDs to fuel growth while maintaining financial discipline. As regulations may differ by country, it is also advisable to consult legal and financial professionals during the CCD issuance process to avoid errors and ensure smooth execution.