What is CCPS? 

CCPS (Compulsorily Convertible Preference Shares) is the main element of start-up financing. They are instruments that compulsorily convert into equity shares of the issuing company on mutually pre-decided conditions at the time of issuance of the instruments.

How is it beneficial for startups and Investors?

CCPSs are playing a very important role in the strategic decision of the company, Investors, and Founders. It is crucial not only for the start-up founders but also for the investors to find the best way to become a part of the company so that not only both benefit from it but also safeguard their interests.

Let’s deep dive into the practical working of CCPS in start-ups.

First, we will understand what Cap Valuation and Floor Valuation is.

Cap Valuation is the very first term that is negotiated in convertibles. Cap Valuation sets the maximum price at which your CCPS will convert. It secures the investor’s interest in the event when the company witnesses immense growth, a thereby dramatic increase in new valuation by fixing the maximum valuation at which CCPS will be converted i.e., Cap Valuation.

Floor Valuation sets the minimum possible valuation at which the convertible security derives its conversion price. The valuation floor serves to protect the founders, ensuring that the new financing round share price is set at a pre-set minimum value.

For a comprehensive view let’s take an example:

Consider an early-stage company, Meta-tech which works in the domain of metaverse shopping. The Company and Investors land on a mutual agreement of a Floor Valuation of 5 cr and a Cap Valuation of 10 cr based on some matrices (matrices could be of footfall, revenue, financials, etc.)

Assume the terms of the deal:

1. In the next 12 months of the current round, if the Company raised INR 1 cr amount or more, the CCPS will be converted at a 20% discount of new valuation keeping in in the Cap Valuation.
2. If the company fails to raise INR 1 cr amount in 12 months, then CCPS will be converted at Floor Valuation

CASE 1 (a): In the next round company raised INR 1 cr amount at the valuation of 12 cr which triggers the first condition, then CCPS will be converted at discounted valuation or Cap Valuation whichever is lower but higher than Floor Valuation.

Now let’s understand numbers:

Assume as an investor you hold 50 quantities of CCPS. Your CCPS will be converted at the valuation of NewValuation*(1-20% discount) i.e., 12(1-20%) = INR 9.6 cr or Cap Valuation whichever is lower. In this case, it is INR 9.6 cr.

So, you will be left with 50*5/9.6 shares which sum up to 26 number of equity shares after conversion.

Case 1 (b): Now let’s assume Meta-tech has witnessed an immense footfall of users and in the next round company raised INR 5 cr (< INR 1 cr) amount at the valuation of 50 cr.

Now, CCPS will be converted at Cap Valuation as discounted valuation is INR 40 cr which is higher than Cap Valuation (INR 10 cr). Thus, CCPS will be converted at Cap Valuation. So, your 50 CCPS shares will convert into 50*5/10 number of equity shares i.e., 25 equity shares.

Case 2: The next round happens after 12 months of the last round. This triggers the second condition.

Your CCPS share will be converted at Floor Valuation i.e., you will get 1 equity share for each CCPS. Thus, you will be left with 50 equity shares after conversion.

Note: In the former case the equity diluted of the company will be less than the latter as less equity is allotted (26 or 25 equity) in Case 1 than in Case 2 (50 equity shares).