Fund Raising in Unlisted Companies: Why CCPS, CCDs and Convertible Notes Have Become the Preferred Investment Instruments

Introduction

Capital is the basic need of business expansion or business growth. Fund raising is a complicated exercise in unlisted companies . Balance of equity and debt is always the first priority of investors. CCPS, CCDs and CNS is the main source of financing in start up and many other countries.

The rise of venture capital, private equity, angel investment and strategic funding has fundamentally transformed the way capital is infused into companies. These investors are not merely contributing money; they are entering into long-term partnerships with promoters. Consequently, investment structures have evolved to accommodate governance rights, valuation concerns, future dilution protection and exit mechanisms. This article explores the significance of CCPS, CCDs and Convertible Notes in modern fund-raising transactions and explains why they have become indispensable instruments in unlisted companies.

The Evolution of Fund Raising in India

Historically, Indian businesses depended heavily on promoter capital and institutional debt. While these traditional mechanisms continue to play an important role, they are often inadequate for businesses operating in fast-growing sectors. Startups and growth-stage enterprises frequently require substantial capital before they generate significant revenues. Such companies may possess strong intellectual property, innovative business models or high scalability, but they often lack the collateral required by conventional lenders.

As India's startup ecosystem matured and global investors entered the market, sophisticated investment instruments became increasingly common. Investors sought structures that would allow them to defer valuation discussions, obtain downside protection and participate in future upside. This need led to the widespread adoption of convertible instruments, particularly CCPS, CCDs and Convertible Notes.

Why Traditional Equity Funding is Often Insufficient

Direct equity issuance appears straightforward, but practical transactions reveal numerous challenges. Determining valuation can become a contentious issue, especially where future growth expectations differ significantly between founders and investors. Founders naturally focus on future potential, whereas investors often evaluate present risks.

Traditional equity also offers limited flexibility. Once shares are issued, restructuring ownership can become difficult. Investors may seek liquidation preferences, anti-dilution protections and enhanced governance rights, which are not inherently available through ordinary equity shares. Convertible instruments bridge this gap by creating a structure that accommodates the commercial objectives of both parties while preserving flexibility for future rounds of funding.

CCPS: The Cornerstone of Venture Capital Investments

Compulsorily Convertible Preference Shares are among the most widely used investment instruments in venture capital and private equity transactions. A CCPS begins as a preference share carrying specific rights and is mandatorily converted into equity shares upon the occurrence of a predefined event or on a predetermined date.

The popularity of CCPS stems from its ability to provide a balanced arrangement between promoters and investors. Prior to conversion, investors may enjoy preferential rights, including dividend preferences and liquidation priority.

For investors, CCPS provides comfort that their capital enjoys a degree of protection while retaining exposure to future value creation. For promoters, CCPS allows capital infusion without immediate dilution of ownership at a level that may be commercially undesirable during the early stages of business growth.

CCDs: Bridging Debt and Equity

Compulsorily Convertible Debentures combine characteristics of debt and equity. Initially, the instrument operates like a debenture. However, unlike conventional debentures, CCDs must convert into equity upon specified terms and conditions.

The attractiveness of CCDs lies in their flexibility. Investors often prefer CCDs when there is uncertainty regarding valuation or when the business requires time to achieve critical milestones. CCDs enable investors to enter at an early stage while postponing final equity participation until the business matures further.

From a transaction structuring perspective, CCDs are particularly useful in private equity investments where significant capital is infused into businesses with ambitious expansion plans. They permit detailed commercial arrangements relating to conversion formulas, governance rights and exit strategies.

Convertible Notes and Startup Funding

Convertible Notes have revolutionized early-stage startup financing. In many startups, arriving at a realistic valuation during the initial stages can be extremely difficult. The business may have a strong vision but limited operational history. Investors and founders may therefore struggle to agree on valuation.

Convertible Notes address this challenge by postponing valuation discussions. The investor contributes capital today, and the instrument converts into equity upon a future funding round or specified event. Frequently, investors receive benefits such as valuation caps or discounts, rewarding them for assuming early-stage risk.

The simplicity and speed of Convertible Notes have made them particularly attractive within the startup ecosystem. They reduce transaction friction while preserving flexibility for future financing rounds.

The Role of FEMA in Foreign Investments

Foreign investment transactions require careful compliance with India's foreign exchange regulations. CCPS and CCDs have become popular among foreign investors because they are generally recognized as equity instruments when structured in accordance with applicable regulations.

However, compliance extends beyond selecting the correct instrument. Pricing guidelines, sectoral caps, reporting obligations and documentation requirements must be carefully evaluated. Improper structuring can result in regulatory complications, penalties and delays

in future transactions.

For this reason, professional advice from company secretaries, legal advisors and transaction specialists is often critical during the fund-raising process.

Investment Documentation: The Foundation of Every Deal

Fund raising transactions are rarely governed by a single document. Instead, sophisticated investments typically involve a suite of agreements designed to allocate rights, obligations and responsibilities among stakeholders.

The Share Subscription Agreement (SSA) governs the terms under which the investor subscribes to securities. It contains representations, warranties, conditions precedent, conditions subsequent and commercial provisions relating to the investment.

The Shareholders Agreement (SHA) regulates the ongoing relationship between promoters and investors. It addresses governance rights, reserved matters, information rights, transfer restrictions and exit mechanisms.

Where CCDs are involved, additional debenture-related documentation may also be required. The quality of documentation often determines the success of the relationship between investors and founders.

Investor Rights in Modern Transactions

Modern investors rarely focus exclusively on ownership percentages. They place considerable emphasis on rights that protect their economic interests.

Liquidation preference provisions determine how proceeds are distributed during a sale, merger or winding up. Anti-dilution protections safeguard investors against future issuances at lower valuations. Information rights ensure transparency through periodic reporting. Board representation allows investors to participate in strategic decision-making.

Tag-along and drag-along rights facilitate exits by balancing the interests of majority and minority shareholders. Collectively, these rights transform an investment from a simple shareholding into a carefully structured commercial relationship.

Common Mistakes Made by Founders

Many founders focus exclusively on valuation while overlooking other critical aspects of investment transactions. An attractive valuation may appear beneficial in the short term but can create difficulties during subsequent funding rounds if performance expectations are not met.

Another common mistake involves inadequate documentation. Ambiguities regarding conversion, investor rights or exit mechanisms often become sources of disputes. Founders also underestimate the importance of regulatory compliance.

Successful fund raising requires a holistic approach that integrates legal, commercial, regulatory and strategic considerations.

Choosing the Right Instrument

There is no universal answer regarding whether a company should issue CCPS, CCDs or Convertible Notes. The appropriate instrument depends on the stage of the business, investor expectations, valuation certainty, regulatory considerations and future fund-raising plans.

Startups often prefer Convertible Notes because they simplify early-stage funding. Venture capital investors frequently favour CCPS due to the combination of protection and future participation. Private equity transactions may utilise either CCPS or CCDs depending on the objectives of the business

The key lies in selecting an instrument that aligns with the long-term goals of both promoters and investors.

Conclusion

The evolution of India's investment landscape has transformed fund raising into a sophisticated strategic exercise. CCPS, CCDs and Convertible Notes are no longer niche instruments used only by large investors; they have become central to modern capital-raising strategies for unlisted companies.

These instruments provide flexibility, facilitate valuation discussions, protect investor interests and create a framework for sustainable business growth. When supported by robust transaction documentation and careful regulatory compliance, they can significantly enhance a company's ability to attract capital and build long-term value.

For promoters, the choice of investment instrument can influence ownership, governance and future growth opportunities. For investors, it determines the balance between risk protection and participation in success. Accordingly, careful structuring of CCPS, CCDs and Convertible Notes remains one of the most important aspects of contemporary fund-raising transactions in India.

Author: CS Prahalad Kumar, in case of any queries please contact/write back to us via email to chhavi@khuranaandkhurana.com or at  Khurana & Khurana, Advocates and IP Attorney.