Section 43 of the Companies Act, 2013 (the “Act”) permits companies limited by shares to issue two primary classes of share capital: equity shares and preference shares. Equity shares may carry standard voting rights or differential rights relating to dividends or voting. Preference shares, by contrast, confer preferential rights as to dividend and return of capital on winding up. While the Act recognises only these two broad categories, it allows flexibility to create multiple classes within each, differentiated by dividend terms, redemption features, conversion rights, and other commercial arrangements.

Within this framework, compulsorily convertible preference shares (“CCPS”) have emerged as a widely used fundraising instrument, particularly in early-stage and private equity transactions. This article outlines the legal framework governing CCPS and examines the factors contributing to their popularity.

Legal Framework

The Act does not specifically regulate compulsorily convertible preference shares. Although it prescribes procedures for issuing equity and preference shares, it contains no express provisions either permitting or restricting CCPS, which are therefore structured within the broader framework applicable to preference shares.

For listed companies, the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 (“ICDR”) apply. CCPS are treated as “convertible securities” under Regulation 2(1)(k). The ICDR permits promoters to subscribe to CCPS to meet minimum promoter contribution requirements and prescribes conversion timelines—18 months for preferential issues and 60 months for qualified institutional placements.

In the case of unlisted companies, no specific conversion period is prescribed under the Act. In practice, the 20-year outer limit applicable to redeemable preference shares under Section 55 is often treated as a guiding benchmark for CCPS tenure.

CCPS as a Strategic Financing Tool

CCPS have become a preferred fundraising instrument for startups owing to their structural flexibility and ability to align founder and investor interests.

From an investor’s perspective, CCPS offer relative downside protection. They carry a preferential right to dividends payable out of distributable profits in accordance with Section 123 of the Act. While dividend payment remains contingent upon the availability of profits, the preferential nature of such returns provides comfort in early-stage ventures where profitability may be uncertain. Importantly, where dividends remain unpaid for two or more years, CCPS holders acquire voting rights on all resolutions, thereby strengthening investor protection.

For founders, CCPS facilitate capital infusion without immediate dilution of shareholding or control. Unlike direct equity issuance, CCPS do not convert into equity at the outset, allowing promoters to defer dilution during the formative years of the company. This makes CCPS particularly attractive where preserving decision-making authority is commercially critical.

CCPS also offer a viable alternative to debt financing. Unlike borrowings that require mandatory servicing through periodic interest payments, dividends on CCPS are payable only when profits exist. This conditional payout structure reduces cash flow strain and preserves working capital. Simultaneously, investors secure entry at the company’s prevailing valuation which is often modest in early stages, while retaining the opportunity to participate in future upside upon conversion at a pre-agreed price.

The instrument’s inherent flexibility further enhances its utility. Key commercial terms such as conversion ratios, conversion pricing, dividend rates, milestone-based triggers, and anti-dilution protections are contractually negotiable, enabling bespoke structuring aligned with the risk allocation agreed between parties. CCPS are also particularly effective in bridging valuation gaps, as conversion mechanics may be linked to future performance benchmarks or contingent events.

From a regulatory standpoint, CCPS have distinct advantages in cross-border transactions. Under India’s foreign investment framework, CCPS are treated as equity instruments rather than debt. Pursuant to the Ministry of Finance press release dated April 30, 2007, CCPS issued or transferred to non-residents are aggregated with equity shareholding for the purposes of sectoral caps under the FDI Policy. In contrast, non-convertible, optionally convertible, and partially convertible preference shares issued on or after May 1, 2007 are regarded as debt instruments and are subject to the External Commercial Borrowings (ECB) framework. The equity classification of CCPS therefore reduces regulatory complexity compared to debt instruments and makes them structurally more efficient for foreign investment.

Further, the Reserve Bank of India has liberalised the dividend regime applicable to CCPS issued to non-residents by removing the earlier cap linked to the SBI Prime Lending Rate plus 300 basis points. This relaxation has enhanced structuring flexibility in foreign investment transactions.

Beyond regulatory advantages, CCPS are widely used in M&A and private equity transactions due to embedded investor protections such as liquidation preference, anti-dilution adjustments, and performance-linked conversion features. Collectively, these attributes make CCPS a sophisticated and commercially balanced instrument for startup financing.

Conclusion

CCPS have emerged as a pivotal instrument in India’s corporate financing framework, particularly in the context of startup funding and M&A transactions. With the continued evolution of India’s entrepreneurial ecosystem and the steady inflow of both domestic and foreign capital, CCPS are likely to remain central to structured investment strategies.

That said, the limited statutory clarity surrounding certain aspects of CCPS underscores the importance of meticulous drafting in shareholders’ agreements and constitutional documents to ensure enforceability and commercial certainty. Greater legislative precision and formal recognition of CCPS within the statutory framework would meaningfully strengthen investor confidence and minimise interpretational ambiguities.

Until such reforms materialise, companies and advisors must operate within the existing regulatory architecture with caution and foresight—capitalising on the structural flexibility and commercial advantages of CCPS while remaining mindful of the legal grey areas that continue to exist.

CCPS: A Strategic Financing Tool for Startups and M&A in India