Convertible Instruments

Compulsory Convertible Preference Shares (CCPS) & Convertible Notes are increasingly becoming preferred investment instrument for investors and promoters.

Conversion of CCPS/Notes to equity are linked to a pre-defined event decided mutually between the investor and the promoters. This pre-defined event is termed as trigger event. Conversion maybe linked to following trigger events:

1.Period

2.Performance Benchmark

Characteristics of Fundraise Raise while issuing Convertible Instruments

• Priced Round: A priced round is an offering and sale of company’s stock at an agreed-upon per-share price. In case of priced round all compliances, issuance procedures are standard to that of equity issuance and the exact holding of the investor is immediately determined.
• Unpriced Round: In an unpriced round the instrument converts at a future date, based on some yet-to-be-determined price.

Why Unpriced Round???

Unpriced rounds are commonly used in

• Early stage fundraises
• Bridge round

In the early stage, determination of valuation of the company is difficult as no premise for the same is available, sometimes the start-ups are at ideation/ idea validation stage.  However, in the bridge rounds there exists gap in valuation expectation between investors and promoters.

Unpriced rounds provide a solution to both the promoters of the company and the investors in following manner

• No immediate valuation required
• Promoters avoid dilution at a lower valuation
• The investor converts their instrument which at a pre-determined discount to the price for new investor in the priced round
• Lower compliances at the time of issuance and the associate cost of the same
• Time saving 

The convertible note has 3 conditions attached to it for providing the accrued holding period benefit to the investor of convertible note:

• Floor: The lowest possible valuation at which the conversion would take place irrespective of the valuation of the round being lower, the conversion for the instrument holder would be at floor or price above as the case may be. This is inserted to provide protection to the company against future risks of adverse circumstances leading to an extreme low valuation.
• Cap: The maximum valuation at which the conversion would take place. This provides for a downside protection of the investor wherein; the maximum valuation is capped & the investor enjoys the tide of growth during the holding period without having to pay the real-time price but the cap price or below as the case may be.
• Discount: This is the premium to the holding period. The investor invests and holds security till the next priced round where the conversion happens at the corresponding price in line with the Floor, Cap and Discount and the investor stake is determined. The expected returns for the holding period are provided to the investor in form of discount to the market price of the security for the round.

Illustration:

Floor: 65 Cr.

Cap: 100 Cr.

Discount: 20%