Procedure of converting debentures into shares

The term Conversion of Debentures into Shares denotes a process under which a Debenture Holder decides to become a Shareholder of the company by converting his/ her Debentures into Shares. Further, after becoming a Shareholder in the company, the said person will get the Right to Vote.

Concept of Debentures

he term “Debenture” denotes a Long Term Security having a Fixed Interest Rate, issued by a Limited Company against the Assets. In other words, Debentures denotes a Certificate Loan issued by a company at a Fixed Rate of Interest.

Further, Section 2(30) of the Companies Act 2013 defines the term “Debenture” as a Debenture Stock, bond, or any other instrument issued by the company for evidencing a debt.

Moreover, Section 71 of the Companies Act 2013 and Rule 18 of the Companies (Share Capital and Debenture) Rules 2020 acts as the Regulatory Framework for the Issue of Debentures.

Introduction convertible debenture

A convertible debenture is a kind of long-term debt which can be transformed into stock after a specific period of time. A convertible debenture is usually an unsecured bond or a loan as in there is no primary collateral interlinked to the debt.

They are long-term debt securities that pay interest returns to the bondholder. A unique feature of convertible debentures is that they can be converted into stock at specified times. It gives the bondholder some security that may put down some of the risks involved with investing in unsecured debt.

Usually, companies issue debt in the form of bonds or equity in the form of shares of stock in order to raise capital. Some companies may use more debt than equity to raise capital for funding operations or vice versa. A convertible debenture can be transformed into equity shares after a specific period. The option of converting debentures into equity shares lies with the holder. A convertible debenture will provide regular interest income via coupon payments and repayment of the principal amount at maturity.

Concept of Equity Shares

The Equity Shares are the primary source of finance for the Company. The Equity Shares give investors the right to vote, profit sharing, and claim on the assets.

They are also called the Ordinary Shares in the Company. No preference is given to these shares regarding the payment of Dividend and while repayment of Capital. The Equity Shareholders are real owners of the Company. Section 43 (a) of Companies Act, 2013 talks about Equity Shares and states:

With voting rights; or
With the right to Dividend, as prescribed by the rules of the Act.

Conditions of conversion of Debentures into equity shares

As per the Rule, 18 of Companies Act, 2013, for debentures following conditions need to be met before issuing Secured Debentures. Also, it should be noted that Rule 18 is applied only on secured debentures.

The secured debentures will be only be issued by the company if the redemption date is less than or equal to 10 years. Only companies dealing in infrastructure projects, non-Banking Financial Companies, Infrastructure Debt Fund and companies permitted by central Government or Ministry or RBI can issue secured debentures for more than 10 years and less than 30 years.
The debentures are secured by charge creation that has the payment value of debenture and interest in it.
The creation of charge will be in name of debenture trustee
The role of the trustee of the debenture and required qualification should be mentioned clearly.
The Debenture Trust Deed should be per Form Sh-12 or as near to it as possible
The company aspiring to create DRR will invest or deposit a sum which is approximately 15% of the debenture amount that is to be matured on 31st March of next year, before April 30th.
The rule does not apply on any amount received against commercial paper issuance by the company or any other instrument of related variables that are per the notification, guidelines, or regulations issued by RBI.
This rule is not applicable to the Foreign Currency Convertible bond issued as per the directions or regulations of RBI or foreign currency convertible Bonds and Ordinary Shares Scheme, 1993.

Advantages of Compulsorily Convertible Debentures

Security Debt- investors are encouraged to put money in CCD as it comes with the promise of conversion to equity shares at the specified time. Also, the conversion of debentures to equity shares is seen in co-relation with the performance of the company by many investors. It Implies that the company only converts the CCD to shares if it has achieved the undertaken growth. If the investors do not observe the achievement of milestone then they can either exercise the put option subject or increase the stake as agreed between parties.
Discount and Pricing- thanks to the CCD issuance the need for straight away fixing the portfolio evaluation has been eliminated. As the investor’s investment is at a nascent stage of Portfolio Company, they are offered a discount to the valuation of the next round of investment on the issued CCD at the issuance time, by the company.
Rate of Interest- the rate of interest paid by the company is lower than the rate of interest paid on the Non-convertible Debentures because issued CCD’s were offered at a discount price. Also with CCD comes tax benefit as at the time of Portfolio Company’s income tax computation, the interest paid to the CCD holder is deducted from income.
Preferential Payment- Preferential right to payment over shareholders goes to CCD holder because of them being the form of debt and not equity as long as they are not converted into equity shares.
Cap Table- if compared to the investment made by the Portfolio Company’s existing shareholders and promoters in the traditional equity shares, investment through CCD is much more lasting, as promoters and shareholders face immediate dilution on receiving the due investment whereas in the case of CCD dilution in the cap table is deferred until their conversion to equity shares.
Debenture Reserve- as per the Companies Act, 2013, for secure payment to be made for Non-Convertible Debenture redemption, Debenture Redemption Reserve, appointing a trustee for Debenture, Debenture Trust Deed, etc. is put in place. However, no such conditions are needed for CCD issuance by the portfolio Company.
The Foreign Direct Investment-FDI has observed a shift in the investment behavior of the investors for the past decade from equity investment to investment through the convertible instrument, for which CCDs can be given a credit for.