CCPS in India: Why Compulsorily Convertible Preference Shares Remain Central to Venture Capital and M&A Transactions 

Compulsorily Convertible Preference Shares (CCPS) remain one of the most widely used instruments for venture capital and private equity investments in Indian companies. Their appeal lies in the ability to combine equity classification with negotiated economic and governance protections. But CCPS are not governed by a single, standalone statutory framework. Their legal treatment is instead shaped by the Companies Act, FEMA and foreign investment rules, tax law, and, where applicable, SEBI regulations. 

Introduction

Indian venture capital transactions frequently use Compulsorily Convertible Preference Shares (CCPS) rather than ordinary equity shares as the primary investment instrument. The reason is straightforward. CCPS can provide investors with preferential economic rights while preserving a contractual mechanism for eventual conversion into equity shares. Depending on the transaction, the terms of issue may address matters such as liquidation preference, dividend rights, conversion ratio, anti-dilution protection, voting rights and the circumstances in which conversion will occur. 

This makes CCPS particularly useful in venture capital and private equity transactions, where the investor may want downside protection and negotiated rights that would be difficult to replicate through ordinary equity alone. However, CCPS should not be viewed as a separate class of security that operates outside the Companies Act, 2013. A CCPS is fundamentally a preference share, and its issuance must be examined through the statutory framework governing preference share capital, together with applicable foreign investment, securities and tax regulations. 

For practitioners, therefore, the more useful question is not simply “Why do investors prefer CCPS?”, but rather: How should CCPS be structured so that the commercial bargain between the investor and the founders remains legally enforceable and compliant across the applicable regulatory regimes? 

What are CCPS? 

Section 43 of the Companies Act, 2013 recognises two broad categories of share capital: equity share capital and preference share capital. Preference share capital carries preferential rights relating to payment of dividend and repayment of capital in specified circumstances. CCPS are preference shares whose terms require them to be converted into equity shares in accordance with the agreed conversion mechanism. This gives the instrument a hybrid commercial character: it is legally share capital, but its terms can be structured to give the investor preferential economic rights before conversion. 

The terms of a CCPS issuance can therefore address, among other matters: 

• the number and series of CCPS; 
• issue price and face value; 
• dividend rights; 
• liquidation preference; 
• conversion ratio or formula; 
• mandatory conversion events; 
• voting rights; 
• anti-dilution adjustments; 
• treatment in a sale or liquidity event; and 
• rights attaching to the equity shares issued upon conversion. 

The precise rights must, however, be reflected appropriately in the company’s corporate documentation, including the terms of issue and, where relevant, the Articles of Association and shareholders’ agreement. 

The Companies Act framework 

There is no standalone chapter in the Companies Act titled “CCPS”. That does not mean, however, that CCPS are unregulated. The starting point is Section 43, which establishes preference share capital as a recognised category of share capital. Section 55 then regulates the issue and redemption of preference shares. It prohibits irredeemable preference shares and generally permits redeemable preference shares for a period not exceeding 20 years, subject to the statutory conditions and the special rule applicable to certain infrastructure projects. 

The important drafting point is that the 20-year rule should not simply be treated as a statutory 20-year conversion period for CCPS. Section 55 principally addresses the redemption of preference shares. A CCPS transaction should instead be structured around its mandatory conversion terms and the applicable provisions governing preference shares and the prescribed conditions for their issue. 

The company’s Articles should also authorise the relevant class of preference shares and contain the necessary enabling provisions. Depending on the structure of the issue, other Companies Act requirements may also become relevant, including those relating to: 

• approval by shareholders; 
• preferential issue/private placement; 
• valuation; 
• disclosure in explanatory statements; 
• allotment and filing requirements; and 
• variation of class rights. 

The legal analysis therefore needs to begin with the transaction structure, rather than assuming that every CCPS issuance follows a single statutory route. 

Why do investors use CCPS? 

The principal attraction of CCPS is that they allow the parties to separate economic protection from ultimate ownership. Consider a Series A investment in which an investor subscribes to CCPS at a negotiated valuation. The investor may receive: 

• a preferential right to proceeds on a liquidation or specified liquidity event; 
• a preferential dividend; 
• a negotiated conversion ratio; 
• anti-dilution protection; 
• information and inspection rights; 
• affirmative voting or reserved-matter rights through the contractual framework; and 
• conversion into equity upon specified events. 

The founders, meanwhile, can avoid immediate dilution of the entire economic and voting structure that would result from issuing the same number of ordinary equity shares at the outset. The instrument therefore provides a useful bridge between the investor’s need for protection and the founders’ need to retain operational flexibility. 

CCPS and valuation

It would be inaccurate, however, to say that CCPS are primarily used to avoid valuation discussions. The issue price of the CCPS itself still needs to be determined and, where applicable, comply with statutory valuation requirements. What CCPS can do is allow parties to negotiate how the investor’s economic position will evolve after the investment, particularly through conversion and preference rights. 

For example, an investor may agree to invest at a specified valuation but negotiate an anti-dilution mechanism that adjusts the conversion ratio if the company subsequently raises capital at a lower valuation. That is materially different from avoiding valuation altogether. 

FEMA: why the distinction between CCPS and other preference shares matters 

The foreign investment framework makes the characteristics of CCPS particularly important. Under the FEMA framework, preference shares qualify as equity instruments where they are fully and mandatorily convertible and fully paid. The RBI’s Master Direction on Foreign Investment in India further provides that, for convertible equity instruments, the price or conversion formula must be determined upfront at the time of issue. The price at conversion cannot be lower than the fair value determined at the time of issuance in accordance with the applicable FEMA framework. 

This has significant drafting consequences for transactions involving non-resident investors. A CCPS term sheet should therefore be examined carefully for provisions such as: 

• optional conversion; 
• redemption rights; 
• guaranteed returns; 
• put or exit rights; 
• conversion formulas that are not determinable at issuance; and 
• mechanisms that could result in the instrument effectively operating as debt. 

The FEMA classification of the instrument cannot be determined merely by calling it “CCPS” in the term sheet. 

The substance and contractual terms of the instrument matter. 

In particular, optionally convertible or non-convertible preference shares are treated differently under the FEMA framework. The RBI’s Master Direction states that preference shares which are not fully, compulsorily and mandatorily convertible are debt instruments for FEMA purposes and are not governed by the NDI Rules as equity instruments. This is one of the most important points for lawyers structuring cross-border venture investments. 

Pricing and conversion mechanics need particular attention 

For a non-resident investment, the conversion mechanics should not be left open-ended. The FEMA framework requires the price or conversion formula for convertible equity instruments to be determined upfront at the time of issue. Further, the price at the time of conversion cannot be lower than the fair value determined at the time of issuance under the applicable FEMA rules. Accordingly, provisions such as the following require careful drafting: 

Fixed conversion ratio: Each CCPS converts into a specified number of equity shares. 

Formula-based conversion: The number of equity shares is determined using a formula specified at the time of issue. 

Anti-dilution adjustment: The conversion ratio is adjusted upon specified future financing events, subject to applicable law. 

Exit-linked conversion: Conversion occurs upon an IPO, sale or other specified liquidity event, with the mechanics clearly established in advance. 

The drafting must ensure that the agreed mechanism remains consistent with the applicable corporate and foreign exchange framework. 

Governance: CCPS do not automatically mean investor control 

One common misconception is that CCPS give investors the same voting rights as equity shareholders before conversion. That is not necessarily the case. 

Section 47 of the Companies Act provides that preference shareholders generally have voting rights only on resolutions that directly affect their rights, as well as specified matters such as winding-up or repayment/reduction of share capital. 

Investor influence in a venture transaction is therefore often achieved through a combination of: 

• statutory voting rights; 
• contractual affirmative voting rights; 
• reserved matters; 
• board nomination rights; 
• information rights; and 
• provisions incorporated into the Articles of Association. 

This distinction is important because rights contained only in a shareholders’ agreement may not always provide the same protection as rights properly reflected in the company’s constitutional documents. A CCPS transaction should therefore be reviewed not merely as a securities issuance, but as part of the broader governance architecture of the company. 

CCPS in M&A and structured transactions 

CCPS are not limited to conventional venture capital financing. They can also be useful in transactions where the parties need to structure consideration or ownership around future events. For example, in a strategic acquisition, the parties may agree that part of the consideration will be satisfied through securities whose economic value depends on specified future events. Similarly, in a transaction involving a staged investment, CCPS can be structured to provide preferential rights until specified milestones are achieved. 

However, practitioners should distinguish a genuine CCPS financing from a contractual earn-out. An earn-out is fundamentally a contingent consideration mechanism linked to future performance. CCPS may be used as the instrument through which that consideration is delivered, but the earn-out itself is governed by the transaction documents and its performance conditions. Where CCPS are linked to business or financial milestones, the conversion mechanism should therefore be aligned carefully with the underlying transaction documents. 

For example, if conversion is linked to revenue, EBITDA or another performance metric, the documents should clearly define: 

• the relevant measurement period; 
• accounting standards or principles to be applied; 
• treatment of extraordinary or exceptional items; 
• treatment of acquisitions or disposals; 
• audit and verification procedures; 
• dispute resolution; and 
• the consequences if the milestone is only partially achieved. 

Ambiguity at this stage can create disputes over both valuation and ownership. 

Tax treatment of conversion 

The conversion of CCPS into equity shares of the same company is also relevant from a capital gains perspective. Under the Income-tax Act, 1961, Section 47(xb) provides that a transfer by way of conversion of preference shares of a company into equity shares of that company is not regarded as a transfer for the purposes of capital gains taxation. 

The corresponding exemption has been carried forward into the Income-tax Act, 2025, which expressly excludes the conversion of preference shares into equity shares of the same company from the definition of a taxable transfer. This means that the conversion itself does not ordinarily constitute the taxable transfer event for capital gains purposes. The subsequent disposal of the equity shares may, however, have its own tax consequences. 

Accordingly, the tax analysis should not stop at the date of conversion. The holding period, cost basis and subsequent exit should also be examined. 

Key drafting considerations for practitioners 

A CCPS transaction should be approached as a multi-regulatory exercise, particularly where foreign investors are involved. 

1. Confirm the corporate authority: Check the Articles, authorised share capital, existing classes of shares and the corporate approvals required for the proposed issuance. 
2. Define conversion mechanics upfront:The conversion ratio, formula, trigger events and adjustment mechanisms should be sufficiently clear to operate without requiring a fresh commercial negotiation at the time of conversion. 
3. Review FEMA implications: Where the investor is a non-resident, confirm that the instrument qualifies as an equity instrument and that the pricing and conversion provisions comply with the applicable FEMA framework. 
4. Distinguish investor protection from prohibited optionality: Put options, assured returns, redemption rights and other exit mechanisms should be examined carefully, particularly in cross-border transactions, to ensure that the overall instrument remains consistent with its intended regulatory classification. 
5. Align the Articles with the transaction documents: Key rights should not be left solely in a shareholders’ agreement where they need to bind the company or affect the rights attached to the securities. 
6. Address anti-dilution carefully: Anti-dilution provisions should specify the adjustment formula, triggering events and exclusions and should be reviewed against applicable corporate and foreign investment requirements. 
7. Consider the exit: The drafting should contemplate what happens on an IPO, strategic sale, secondary transaction, change of control or other liquidity event. 
8. Keep tax and accounting consequences separate: The legal character of CCPS does not necessarily answer every tax or accounting question. The parties should separately evaluate the applicable tax and accounting treatment at issuance, conversion and exit. 

Why CCPS remain relevant 

The continuing popularity of CCPS is not simply a consequence of regulatory convention. They remain commercially useful because they allow sophisticated investors and founders to allocate risk over time. At the time of investment, the investor can obtain preferential economics and negotiated protections. As the company matures, the instrument can convert into ordinary equity and participate in the company’s long-term value creation. This is particularly useful in businesses where the commercial valuation is expected to evolve rapidly between funding rounds. 

The instrument therefore provides a contractual bridge between two stages of a company’s life: investment protection today → equity participation tomorrow. 

Conclusion

CCPS have become an important feature of Indian venture capital and private equity transactions because they combine the legal characteristics of preference share capital with considerable flexibility in allocating economic and governance rights. But their flexibility does not place them outside the regulatory framework. 

For an Indian company, the starting point remains the Companies Act, 2013 and the rules governing preference shares and their issuance. Where a non-resident investor is involved, FEMA and the NDI Rules become critical, particularly in relation to the classification, pricing and conversion mechanics of the instrument. The tax treatment of conversion must also be considered under the current Income-tax Act, 2025. For listed companies, the applicable SEBI framework must additionally be examined. The most important lesson for transaction counsel is therefore simple: 

A CCPS is not merely a funding instrument. Its terms determine how corporate law, foreign exchange law, taxation and investor protection interact throughout the life of the investment. 

Careful drafting at the issuance stage particularly around conversion, pricing, anti-dilution, investor rights and exit mechanics, can prevent a financing instrument intended to provide flexibility from becoming a source of regulatory or contractual uncertainty later. 

Last Updated on 19 August, 2026