A Compulsorily Convertible Debenture (CCD) is a hybrid instrument that begins as debt but mandatorily converts into equity at a pre-agreed event or date. It allows founders to raise capital without immediate dilution and enables investors to defer valuation discussions.

However, a CCD agreement is far more than a simple funding document. It is a comprehensive framework defining the economics, governance, rights, obligations, and exit pathways between founders and investors. A slight variation in drafting can significantly affect valuation, conversion, compliance, and control.

Based on my practical deal experience, the important clauses that every founder must understand before signing a CCD agreement are listed below.

1. Conversion Terms – The Core of the Deal

Conversion Formula / Price

This clause dictates how many shares the investor ultimately receives.
Common structures include:

a. Fixed conversion price (e.g., ₹X per share)
b. Formula-based conversion linked to future valuation
c. Conversion based on the next round price

Any ambiguity here directly affects founder dilution.

Conversion Timeline

Typically includes:

a. Mandatory conversion date (to avoid “deposit” classification under the Companies Act & FEMA)

b. Event-based triggers such as:

1. 1. Next qualified funding
   2. Change in control
   3. IPO
   4. Long-stop date expiry

This determines when debt becomes equity—even if founders are not ready.

2. Valuation Cap & Discount – Founder Dilution Guardrails

Valuation Cap

Sets the maximum valuation at which CCDs will convert.
Protects investors if the company skyrockets before the next funding round.

Example:
If the cap is ₹40 crore, conversion will not happen above that valuation, even if the next round happens at ₹60 crore.

Discount on Next Round

A standard early-stage investor typically asks for a 10%–25% discount.
Investors receive shares at a lower price than new investors, rewarding their early risk.

In a CCD, the cap and discount together determine how much the investor ultimately gains and how much the founder is diluted.

3. Interest, Payment Terms & Tax Treatment

Although CCDs behave like equity at conversion, they are treated as debt on the books until then.

a. Interest rate (simple interest, often low or 0%)
b. Accrual vs. payout
c. Whether interest converts or is paid before conversion

Founders should also evaluate the tax-deductibility of interest and the impact on cash flow.

4. Liquidation Preference

Before CCDs convert, they typically rank senior to equity.
After conversion, the liquidation preference clauses decide:

a. Payout priority on sale/merger/liquidation
b. Whether it is:

1. 1. 1x non-participating
   2. Participating
   3. Pari-passu with other investors

This clause alone can significantly change the founders’ proceeds in an exit scenario.

5. Anti-Dilution – Protection Against Down Rounds

If the company raises capital at a price lower than the investor’s entry price, anti-dilution gets triggered.

Common mechanisms:

a. The investor fully reprices to a new, lower valuation
b. Market-standard method

The agreement usually recalibrates:

a. Conversion ratio, or
b. Number of shares to be issued, or
c. Reference shareholding percentage, to keep investors protected.

6. Exit Rights – How the Investor Gets Out

Most CCD agreements incorporate multiple exit mechanisms:

a. Strategic Sale / Buyout Route

The agreement may allow a defined timeframe or valuation level for sale to third parties.

b. Rules Around Selling to Competitors

Often restricted unless the company waives or fails to buy back.

Exit rights ensure investors have predictable downside protection even if conversion is delayed.

7. Transfer Restrictions – Who Can Hold the CCDs

Typical restrictions include:

a. Right of First Offer (ROFO) for promoters
b. No transfers to competitors
c. Lock-in periods
d. Mandatory deed of adherence for any transferee

These clauses help the company control its cap table.

8. Investor Protection Rights

Modern CCD agreements also include governance rights, such as:

a. Board Observer Rights

Investor representative attending all board meetings (non-voting).

b. Reserved Matters

Investor consent is mandatory for key corporate decisions such as:

a. Altering share capital
b. Issuing new securities
c. Modifying CCD terms
d. Changing constitutional documents
e. Major transactions, M&A, asset sale
f. Litigation beyond a threshold

These clauses often give investors veto power on material decisions.

9. Pre-Emptive Rights – Protecting Ownership Percentage

CCD investors may need to maintain their ownership in future rounds.
Pre-emptive rights allow them to:

a. Subscribe to their pro-rata share in future issuances
b. Avoid dilution before conversion

Sometimes pre-emption is restricted only to the equity stage; sometimes it applies even at the CCD stage.

10. Conditions Precedent (CPs) –

Before funds are released, the investor requires:

a. Board and shareholder approvals
b. PAS-4, PAS-5, PAS-3 compliance
c. Valuations
d. Amended charter documents
e. Cap table certifications
f. Waivers (if required)
g. Representations & warranties

CPs ensure the company is fully compliant and “transaction-ready”.

Conclusion

A CCD agreement is not merely a funding document—it is a powerful governance, conversion, and protection framework that directly influences:

1. Founder dilution
2. Investor upside
3. Control dynamics
4. Exit pathways
5. Future fundraising

Founders should approach CCD drafting with the same level of rigor as an SHA or SPA. Even a seemingly minor clause can materially influence outcomes at the time of conversion or exit.

For any clarifications or queries, please feel free to reach out to us at admin@fintracadvisors.com

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