Understanding Compulsorily Convertible Debentures for Start-Up
When a Start-up proposes to raise money, the biggest confusion that they have is whether to raise it in the form of equity or debt. Raising in the form of equity dilutes their stake in the company whereas debt comes with its huge rate of interest which they, being an at early-stage, may not be able to service. Thus, they look out for alternatives which can help them strike a balance between debt and equity. Here comes Compulsorily Convertible Debentures (CCD).
CCD is a kind of Debenture which is compulsorily converted into equity at a later date. Most of the early-stage and growth-stage start-up prefer issuing CCD as it may not carry any interest rate or may carry nominal interest rate unlike other debt instruments. At the same time, investors also prefer acquiring CCD over direct equity. The reason being CCD gives them liquidity preference over equity till they are converted.
Now, let us look at the advantages of issuing CCD for the Company and for the Investor.
Advantages for the Company:
- No dilution of equity initially as conversion happens at a future date.
- No need to increase authorized capital at the time of issue as CCD forms part of Debt till conversion.
- No mandatory payment of interest on CCD, CCD can be zero coupon also.
- No voting rights to CCD holders till they are converted or default happens.
- No need to follow strict External Commercial Borrowing (ECB) guidelines in case of investment from foreign residents as CCD is covered under Foreign Direct Investment (FDI).
Advantages for the Investor:
- CCD gives them liquidity preference over equity at the time of liquidation.
- CCDs are transferable.
- The conversion period of CCD can be up to 10 years.
- The conversion price/formula is fixed at the time of issue.
- Easy for Non-residents to invest through CCD as FDI rules are applicable.
In recent times, CCDs have gained lot of popularity among start-ups due to their hybrid nature and ease of compliance. They are preferred over other kind of instruments as it gives flexibility to both the Company and the Investor. However, choosing the right kind of instrument depends on various other factors relating to the Company and the Investors’ intent.
If you’re looking for advisory on the right instrument for your company, then our product SimplyTransact is just meant for you. Please get in touch with our SimplyTransact team of SimplyBiz for proper advisory and effective execution through digital workflow and dashboard for easy communication.