When investors enter the cap table of a startup, they are given preference shares – shares that have rights to liquidate during the lifetime of the company. In India, these preference shares are generally issued as a class of CCPS or Compulsory Convertible Preference Share. The latest class of CCPS has a higher preference than its preceding classes, when it comes to payout, meaning a Series B CCPS will have higher preference over Series A CCPS, so on and so forth.
CCPS is defined as a corporate fixed-income or hybrid security that may be converted into a certain number of shares of the company’s common stock after a predetermined time span, on a specific date, or on specific events such as M&A and IPOs. It is important to note that startups keep the dividend rate of these instruments nominal, say 0.001%. The dividend, therefore, becomes negligible for startup investors.
Investors, who are granted Compulsory Convertible Preference Shares or CCPS, have the privilege of linking the time of conversion to the company’s performance. This essentially means that the investor might choose to convert CCPS to equity only after the company achieves the promised growth. If these milestones are not achieved, then investors may also have the option to increase their stake in the startup.
At times, there might be a ratio linked to the conversion of CCPS to equity shares. The ratio is generally 1:1, meaning 1 CCPS upon conversion will become 1 equity share. But, there might be instances where the conversion ratio is 1:1.5, 1:2. 1:3 or in any other proportion. Such conversion ratios are generally seen when advisors or promoters demand more shares. The conversion ratio is generally agreed upon in the Shareholder Agreement (SHA).
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