Raising capital? Choosing the right instrument is just as critical as finding the right investor.
For many Indian startups, the debate often settles on Compulsorily Convertible Debentures (CCDs) vs. Optionally Convertible Preference Shares (OCPS). While both are popular routes for fundraising, they impact your company’s valuation, tax liability, and cap table in drastically different ways.
At My Valuation, we see founders struggle with this choice daily. The wrong decision can lead to unexpected tax burdens or excessive equity dilution down the line.
This guide breaks down the valuation differences between CCDs and OCPS, helping you make a data-backed decision for your next funding round.
What is the Main Difference Between CCDs and OCPS?
If you need a quick answer for your pitch deck or internal meeting, here it is:
The core difference exists in the certainty of equity conversion.
- CCDs (Compulsorily Convertible Debentures): These represent debt that must convert into equity after a specific period or event. They are treated more like deferred equity. The valuation focuses heavily on the future enterprise value at the time of conversion.
- OCPS (Optionally Convertible Preference Shares): These give the investor a choice (option) to convert into equity or redeem their money back. Because there is an "option" involved, the valuation is more complex, often requiring option-pricing models (like Black-Scholes) to account for that flexibility.
CCDs offer certainty of conversion, making them simpler for cap table management. OCPS offers flexibility to the investor, which adds layers of complexity to the fair value calculation.
CCD vs. OCPS: A Quick Comparison Table
For busy founders and CFOs, here is the snapshot view of how these instruments compare.
| Feature | Compulsorily Convertible Debentures (CCDs) | Optionally Convertible Preference Shares (OCPS) |
|---|---|---|
| Nature of Instrument | Hybrid (Debt converting to Equity) | Hybrid (Equity with debt-like redemption option) |
| Conversion Status | Mandatory (100% conversion) | Optional (Investor choice) |
| Valuation Complexity | Moderate | High (requires option pricing) |
| Returns to Investor | Interest (Tax-deductible expense) | Dividend (Post-tax appropriation) |
| FEMA Guidelines | Treated as Equity for FDI (if fully convertible) | Treated as Debt (unless fully convertible) |
| Impact on Valuation | Discounted Cash Flow (DCF) is primary | DCF + Option Pricing Models (Black-Scholes) |
| Ideal For | Startups wanting clear equity paths | Investors wanting downside protection |
Why Valuation Methodologies Differ for CCDs and OCPS
The valuation methodology isn't just a math exercise; it dictates how much of your company you are giving away.
When our team at My Valuation conducts Valuation of Complex Financial Instruments, we approach these two instruments differently.
1. How We Value CCDs (The "Future Equity" Approach)
Since CCDs must convert, they are essentially equity-in-waiting.
- Primary Method: Discounted Cash Flow (DCF).
- The Logic: We project the startup's future cash flows and discount them back to the present value. Since the debt will expire and become shares, we value the company as if the shares are already issued (fully diluted basis).
- The "Discount" Factor: Often, CCDs are issued at a discount to the next funding round valuation. We calculate the theoretical price per share today based on that future trigger event.
2. How We Value OCPS (The "Option" Approach)
OCPS is trickier. The investor holds a "ticket" that lets them choose between cash (redemption) or shares.
- Primary Method: DCF + Option Pricing Models (OPM).
- The Logic: We must value the underlying business (via DCF) AND the value of the "option" the investor holds.
- The Math: We often use the Black-Scholes Merton model or Binomial Lattice models. These models calculate the probability of the investor converting vs. redeeming.
- If the company booms: They convert (High value).
- If the company struggles: They redeem (Debt value).
- Result: The Fair Value of OCPS is often higher than plain equity because it carries this "safety net" for the investor.
The Tax Impact: Interest vs. Dividends
Your choice between CCDs and OCPS directly affects your P&L and cash flow.
CCDs: The Tax Shield Benefit
Investors holding CCDs receive interest until conversion happens.
- For the Startup: This interest payment is a tax-deductible expense. It lowers your taxable income, saving you cash.
- For the Investor: Interest is taxed as normal income.
OCPS: The Dividend Disadvantage
Investors holding OCPS receive dividends.
- For the Startup: Dividends are paid out of post-tax profits. You pay corporate tax first, then pay the investor. There is no tax shield.
- For the Investor: Dividends are taxable in their hands (subject to specific exemptions or rates).
If your startup is burning cash and has no taxable profit, the "tax shield" of CCDs might not matter yet. However, for profitable SMEs, CCD interest can significantly optimize tax liability.
FEMA Guidelines and Foreign Investment (FDI)
Are you raising funds from foreign VCs or angels? The Foreign Exchange Management Act (FEMA) treats these instruments differently.
The "Equity" Rule for FDI
For an instrument to be considered "FDI-compliant" (eligible for the automatic route), it must be equity-like.
- CCDs: Must be fully and mandatorily convertible. If there is any option to redeem them for cash, FEMA treats them as External Commercial Borrowings (ECB), which has strict caps and compliance headaches.
- OCPS:Since these have an "option" to redeem, RBI often views them closer to debt. To be treated as FDI equity, OCPS must essentially act like equity (long tenures, minimal redemption rights).
Why this matters for valuation: For FDI, the conversion price cannot be lower than the Fair Market Value (FMV) of the shares at the time of issuance. You will need a Merchant Banker or Chartered Accountant to issue a valuation certificate ensuring you aren't pricing the round too low.
Need a FEMA-compliant valuation report? Explore our Valuation for FEMA/FDI purposes.
How Founders Lose Equity: Dilution Scenarios
The scariest part of convertible instruments is the "unknown dilution."
The "Valuation Cap" Trap
Both CCDs and OCPS often come with a Valuation Cap.
- Scenario: You raise money via CCDs with a cap of ₹50 Cr.
- Reality: If your startup explodes and is worth ₹100 Cr at the next round, the CCD holders still convert at the ₹50 Cr valuation.
- Result:They get twice as many shares as the new investors for the same price.
The OCPS "Liquidation Preference"
OCPS holders often have superior rights during a liquidation event (sale of the company). They get paid first.
- If the company sells for a mediocre amount, OCPS holders might choose to redeem their cash + dividends, leaving little for common shareholders (founders).
- Valuation Nuance: When we perform Startup Valuation Services, we must model these "waterfall" scenarios to show founders exactly how much they would walk away with in different exit scenarios.
When Should You Choose CCDs?
Opt for Compulsorily Convertible Debentures if:
- You want certainty:You know the debt will disappear and become equity.
- You want tax efficiency: You want to expense the interest payments.
- You are raising FDI: Mandatory conversion is the easiest path for foreign funds.
- You want simpler valuation: You want to avoid complex option-pricing discussions.
When Should You Choose OCPS?
Opt for Optionally Convertible Preference Shares if:
- Investors demand safety: Your investors want the option to pull their money out if the business stalls.
- You have accumulated losses: Paying dividends might not be an immediate concern.
- You want structural flexibility: You are okay with the added complexity of option valuation to close the deal.
Conclusion: Don't Just Guess - Define It
The difference between CCDs and OCPS isn't just legal jargon - it’s the difference between a clean cap table and a chaotic one.
Whether you are issuing convertible notes, warrants, or complex derivatives, the valuation methodology you choose today will dictate your ownership tomorrow.
Don't leave your equity to chance.
At My Valuation, we specialize in the Valuation of Complex Financial Instruments and Startup Valuation Services. We help founders, CFOs, and investors understand the real numbers behind the deal.
Ready to value your convertible instruments accurately? Get a Quote for Your Valuation Report Explore Our Virtual CFO Services
