CONVERTIBLE DEBENTURES

A convertible debenture is a type of long-term debt issued by a company that can be converted
into stock after a specified period.

Convertible Debentures earn less interest since debt holder has option to convert the same into
shares, therefore being exposed to lower risk.

i. Optionally Convertible Debentures: The holder/ investor has the option to either
convert the debentures into shares after a fixed period or wait till the maturity of the
debentures, upon which the principal amount is repaid by the company. During this
period the debenture holder keeps receiving the interest. Investor has the right to
convert debt into equity.
ii. Compulsorily Convertible Debentures: These are different from the above since the
holder/ investor has no option to either convert or wait till the maturity of the
debentures. In this case, the debentures are compulsorily converted to shares. These
debentures are treated equity for the purpose of reporting to RBI.

Partial and Complete Conversion:

Partial conversion is when a certain portion of the debentures can be converted into shares;
whereas in the case of complete conversion, the entire debt is converted into shares.

Conversion Ratio:

Determines the number of shares per debenture. This is usually determined at the time of
issuance of debt. The higher the ratio, the higher the number of common shares exchanged per
convertible security, i.e., convertible debenture. The conversion ratio is determined at the time
the convertible security is issued and has an impact on the relative price of the security.
Zero Coupon Convertible:

Zero Coupon means no interest but deep discounts. This convertible is a non interest paying
bond which gets converted into shares when the stock reaches a certain point.

These bonds have a lower risk than purchasing pure equity, given that the underlying shares of
zero-coupon convertibles have high volatility. However, zero coupons have a built-in option
which allows the issuer to force the conversion of the bonds when the stock performs as
expected, capping the investor’s upside potential.

The formula for calculating the yield to maturity on a zero-coupon bond is:

Yield To Maturity = (Face Value/Current Bond Price)^(1/Years To Maturity)−1

 Major Clauses in Compulsorily Convertible Debentures

The following are some important clauses which form a part of the CCD Subscription
Agreement-

1. Closing: Consummation of purchase of subscription debentures. May include other

action by the parties as may be stated in the subscription agreement.
2. Conditions precedent: To be fulfilled by the company before subscription may be made.
3. Conversion Date: Date on which the compulsory conversion of debentures take place or
become due.
4. Obligations of the Promoters:
a. Obtain consent from the board of directors, shareholders and lenders.
b. Increase authorized share capital to accommodate the paid up capital of the
company after conversion happens.
c. Provide copy of board resolution by approving the draft debenture subscription
agreement and authorize a person to sign/ execute on behalf of the company.
d. Hold a meeting of shareholders to approve the increase in authorized share capital.
e. Meeting of shareholders to also adopt Restated Articles.
5. Information: From the effective date till the time the investor holds the debentures, the
company must keep him informed about its progress and operations in the manner as
may be prescribed by the investor.
6. Right of First Refusal: ROFR
Parties may not transfer any of their securities without first obtaining the prior written
permission of the other party. Both the parties shall have a right, but not the obligation,
to purchase the sale shares, as the case maybe, from the selling shareholder.
7. Tag Along (after refusal):
If a party refuses to purchase (ROFR), tag along comes into play. Tag along may also be
refused within a stipulated time from the date the sale notice is received. If not, the
selling party may sell share within a specified time. If the selling party fails to sell shares
within that period, ROFR and tag along are revived.
Drag along rights may be similarly placed.
8. Lock In: Promoter not be entitled to transfer to any person, the shares held by it in the
Company, directly or indirectly, for a specified period calculated from the date of
closing.
9. Anti Dilution Protection: If after closing, the Company issues any securities, at a price
per security that is lower than the price paid for the Debentures (or their conversion
price), then the Investors shall be entitled to anti-dilution protection.
10. Affirmative Voting Rights: The Company and its shareholders shall not be permitted to
take any decisions on certain matters without such matters having first received the
approval of the Investor.
11. Liquidation Preference: The holder/ investor shall be entitled to preferential right to
distribution from the Company or from third parties, as the case may be, over all other
shareholders, upon the occurrence of a liquidation event.
12. Exit Options:
The company and the promoters shall make all reasonable endeavors to provide exit to
the investor by:
(a) an initial public offering of the Company at a mutually agreed minimum valuation
within a specified time from the date of closing; or
(b) strategic sale of the debentures at the price acceptable to the investor a specified time
from the date of closing.
OR
Drag Along Option: If the company and the promoters fail to provide an exit as above,
the investors shall have the unilateral right to sell the debentures to any third party and
the right to drag along the Promoters requiring the promoters to sell whole of part of
their shares, if required by such third party, to enable exit by the investors.