Compulsory Convertible Debentures offer a variety of beneficial features to the investors and continue to display enticing risk/rewards properties within a diversified portfolio. Convertible debentures are gaining a lot of traction and foreign investments also enter India through these hybrid financial instruments.
Foreign Direct Investment (FDI) trends for the past decade clearly depict that there has been a phenomenal shift from the traditional investments to the convertible instruments primarily the Compulsory Convertible Debentures.
So, we thought of digging deeper into: What is a Compulsory Convertible Debenture? What are the advantages of CCDs? Should Compulsory Convertible Debentures be the preferred investment instrument?
What is Compulsory Convertible Debenture or CCD? Meaning
Compulsory Convertible Debenture refers to the debentures that must be converted into equity after a specified period of time. Simply stating, the company that issues CCDs has to convert it into equity after the predetermined period. Once the CCDs get converted, the debenture holders automatically turn into shareholders of the company and enjoy all the rights of a shareholder.
So, CCDs being a hybrid investment tool, are in the form of debt while issuing till the time they are converted into equity. After a certain period, they have to be compulsorily converted into equity shares.
But, CCDs are considered as equity for all reporting purposes as well as financial statements, as per RBI guidelines. However, till the time CCDs are converted into equity, the company can’t consider them as a part of their share capital.
Further, as per FDI guidelines, if a non-resident contributes towards CCDs that shall be regarded as equity investment only.
Also Read: Understanding NCDs
Why do Companies issue Compulsory Convertible Debentures?
The companies usually prefer issuing CCDs due to the convenience and flexibility associated with them. These convertible debentures act as a great fund-raising alternative especially for start-ups planning to raise money at the initial stages in order to expand or maintain their business.
Also, the market driven valuation of the new company can be pushed to a later date since there is no urgency to fix its valuation straight away.
Compulsory Convertible Debentures: Advantages to Know
Now, let us have a look at the numerous benefits attached to these convertible debentures:
1. A Secured Debt:
CCDs seem to be an attractive option owing to the fact that they shall convert into equity shares in future. The investor’s belief that conversion of CCDs is correlated with the company’s performance further strengthens it to be a good choice being a secured debt. This encourages more and more investors to put in their money into this lucrative investment variant.
2. Clear Terms & Conditions:
The terms & conditions of a Compulsory Convertible Debenture are decided upfront at the time of their issuance. The price/conversion formula of CCDs is also determined at the time of their issue. This adds more transparency to the system and makes it a reliable long term investing option.
3. Pricing and Discount benefit:
A Compulsory Convertible Debenture is generally offered at a discount since the investor is investing at very early stage of the company. There is no hassle to fix the company valuation and this can be deferred on to a later stage. This is indeed a big sigh of relief for the company prior to the valuation of the next investment round.
4. Lower Rate of Interest:
The issuance of CCDs at a discounted price enables the company to pay a lower rate of interest as compared to Non-Convertible Debentures (NCD). But, the investors are willing to accept even lower interest on these convertible debentures due its ease of conversion into ownership stake of the company later on. From company’s point of view, CCDs help to grab the tax benefit on the interest paid to the CCD holder.
5. Investor’s Right to Preferential Payment:
CCD is a debt instrument until its conversion to equity shares. So, being a CCD holder, you have the preferential right to payment over other stakeholders of the company.
Also Read: Take Hint from FIIs Money
Compulsory Convertible Debentures: A Final Take
A Compulsory Convertible Debenture, is a quite familiar term in the established as well as the emerging start-up ecosystem. It has gained a lot of popularity due to the wide flexibility associated with it. Moreover, there is no immediate dilution in the cap table of the company and the same is postponed till the conversion of CCDs.
Although, there is a regular compliance work involved in these convertible debentures, from a company’s perspective. But, still the bulk of advantages provided by this hybrid tool are manifold and can’t be ignored. In addition to it, these convertible debentures are a fruitful way to attract Foreign Direct investment into the country.
From investor’s point of view, these Compulsory Convertible Debentures can be a preferred investment as far as they meet their long term financial objectives.
What’s your take on this hybrid investment instrument, Compulsory Convertible Debenture? Feel free to drop in your opinions on the same.