Why VCs get Compulsorily Convertible Preference Shares and not Equity shares? – Varsity by Zerodha (2024)

FAQs

Why VCs get Compulsorily Convertible Preference Shares and not Equity shares? – Varsity by Zerodha? ›

CCPS has precedence over common equity shareholders in two ways – before paying any dividends to equity shareholders, CCPS holders receive dividends, and if the company goes bankrupt and has to sell its assets, CCPS holders will receive a return on their capital on a priority basis when compared to the other ...

Priority in Receiving Dividends: CCPS holders have priority over common stockholders in receiving dividends, which can provide a stable income stream. Reduced Risk: CCPS are generally considered a low-risk investment, as they have priority over common stock in receiving dividends and in the event of liquidation.

Conversion options: Each CCPS shall be compulsorily convertible into 10 Equity Share of the Company. Each holder of CCPS may convert CCPS held by it in whole or part into Equity Shares at any time not later than 20 years from the date of issuance.

The issuance of CCPS follows a structured procedure. It starts with a board meeting to approve the CCPS terms, followed by a shareholders' meeting to pass a special resolution authorizing the issuance. If needed, the company's Memorandum of Association is updated.

Equity shares have voting rights and potential for higher profits, but they're riskier and fluctuate more. Preference shares provide stable fixed dividends but often no voting rights and lower returns.

Convene and hold a Board Meeting for passing the resolution for conversion of compulsorily convertible preference shares into equity shares of the company. In case of listed company, immediately within 15 minutes of the conclusion of the Board meeting, intimate the STOCK EXCHANGES with regard to the Board's decision.

This CCPS has extra perks, like interest getting paid back first if the business makes profit , but you have to exchange it for equity at a specific time. For example, 1 CCPS is equal to 10 equity shares after 18 months.

Drawbacks. The Securities and Exchange Commission warns investors that convertible shares may depress the value of common shares by diluting them. 2 Another drawback is that convertible preferred shareholders, unlike common shareholders, rarely have voting rights.

Convertible notes offer flexibility for startups with potential downside protection for investors. Equity provides investors with the most control but comes with the risk of dilution for founders. SAFEs offer a balance between the two, with a focus on simplicity and potential benefits for both founders and investors.

Unlike ordinary equity investment instruments such as stocks and bonds, where people can invest regardless of what stage the company is in, preference shares are usually bought by investors who are looking for a more secure investment with a fixed income.

What happens if CCPs are not converted? ›

Limited Control for Preference Shareholders: While CCPS holders have preference rights, they may have limited or no voting rights until conversion. This means that, until conversion occurs, preference shareholders may not actively participate in certain key company decisions.

The convertible preferred stock advantages to an investor include high dividend yield, flexibility, and potential for capital appreciation. To the issuer, convertible preferred stock can increase a company's equity or capital.

Yes, it is possible. The procedure shall be the same as the one prescribed under Sections 68, 69, and 70 of the Companies Act 2013 and relevant rules.

It's all about the limit order: Since preference shares aren't exactly flying off the shelves, you might need to set a specific price (a limit order) to snag one. Patience is a virtue: Remember, uncle is on his own schedule when it comes to showing up (or, in this case, being available for purchase).

Convertible preference shares are those shares that can be easily converted into equity shares. Non-Convertible preference shares are those shares that cannot be converted into equity shares.

Equity shares offer voting rights. Preference shares usually do not offer any voting rights. As equity shareholders enjoy voting rights, they can also participate in management decisions. Preference shareholders are usually not allowed to participate in management decisions.

These shares carry certain terms—if an early investor has CCPS, he can have more rights than other investors who come in later at a higher valuation. It also helps investors maintain their stake and have a say even if their stake gets diluted later.

Many fast-growing companies would prefer to use debt to support their growth, rather than equity, because it is, arguably, a less expensive form of financing (i.e., the rate of growth of the business's equity value is greater than the debt's borrowing cost).

The advantages of debt financing are numerous. First, the lender has no control over your business. Once you pay the loan back, your relationship with the financier ends. Next, the interest you pay is tax deductible.

Common stock provides a degree of voting rights to shareholders, allowing them an opportunity to impact crucial managerial decisions. Companies that want to limit the control they give to stockholders while still offering equity positions in their businesses may, therefore, turn to preferred stock.