If you're in the startup world, "CCPS" is a term you hear in every funding discussion. But what does it actually mean?
Compulsory Convertible Preference Shares (CCPS) are the most popular financial instrument used in startup funding rounds in India.
Think of them as hybrid security. They act like special "preference" shares for a while, giving investors protective rights, and then must convert into regular equity shares at a later, pre-defined date or event.
This dual nature makes them attractive to both founders and investors. But it also makes it very difficult for them to value it correctly. A simple mistake can impact your cap table, future funding rounds, and even your legal compliance.
At My Valuation, we specialize in describing complex financial instruments. This guide explains everything you need to know about CCPS and the critical process of their valuation.
What Exactly Are Compulsory Convertible Preference Shares (CCPS)?
Let's start with the basics. CCPS is an instrument that gives an investor preferred rights to common equity shareholders.
The "compulsory convertible" part is key. It means that, unlike optional convertibles, these shares must convert into equity. This is usually driven by:
- A specific date (e.g., 3 years from investment).
- A specific event (e.g., the next qualified funding round, an IPO, or a sale of the company).
Until that conversion happens, the CCPS holder has "preference," which usually includes a liquidation preference. This means if the company is sold or shut down, they get their money back before the founders and other equity holders.
Why Do Startups Use CCPS for Funding?
CCPS has become the default for venture capital because it brilliantly solves problems for both sides of the table.
What are the Benefits for Investors?
Investors love CCPS because it gives them downside protection with upside potential.
- Liquidation Preference: As mentioned, they get paid first. If a startup sells less than expected, investors are more likely to refund their capital.
- Anti-Dilution Rights: This is crucial. If the startup raises its next round at a lower valuation (a "down round"), the CCPS conversion ratio adjusts to give the investor more shares, protecting their ownership percentage.
- Dividend Rights: CCPS holders are technically entitled to a dividend (if one is declared) before equity holders. In practice, high-growth startups rarely pay dividends, but the right still exists.
What are the Benefits for Founders?
Founders often agree to CCPS because it helps them secure capital while setting up a foundation for future growth.
- Securing the Investment: It's often non-negotiable for VCs.
- Defined Terms: It aligns incentives. Investors are motivated to help the company grow, so their shares are converted into valuable equity.
- Attracting Lead Investors: A clean CCPS structure from a lead investor makes it easier to bring in smaller, follow-on investors in the same round.
How Do CCPS Differ from Other Funding Instruments?
It's easy to get lost in the alphabet for funding. Here’s a simple comparison.
CCPS vs. Equity Shares: What's the Difference?
The main difference is rights.
Equity Shares (or "common stock") represent pure ownership. You have voting rights, but you are last in line to get paid if the company liquidates.
CCPS are "preference" shares first. They have limited voting rights (usually only on matters affecting them) but are first in line for payouts (up to their preference). Only after conversion do they become identical to equity shares.
CCPS vs. Compulsorily Convertible Debentures (CCD): Which is Better?
This is a common point of confusion. Both are "compulsorily convertible."
CCDs are debt instruments. They carry a fixed interest rate (which must be paid) and are treated as a liability on the balance sheet. In bankruptcy, debt holders get paid before even preference of shareholders.
CCPS are treated as equity-like instruments. They carry a "dividend," which is only paid if the company is profitable and declares one. For regulatory purposes like FDI (Foreign Direct Investment), CCPS are considered part of equity.
For most high-growth, non-profitable startups, CCPS is the preferred route as it doesn't burden the company with mandatory interest payments.
How to Value CCPS: The Core Challenge
This is where things get complex. You can't value CCPS by just looking at the company's current stock price, because it doesn't have one.
The value of a CCPS is not just its current stake, but a promise of a future stake with current protections. Its value depends on many moving parts, including:
- The total valuation of the company (pre-money and post-money).
- The size of the liquidation preference (e.g., 1x, 2x).
- The probability of different future outcomes (e.g., IPO, sale, bankruptcy).
- The time until conversion.
- The rights of other share classes (e.g., Series A vs. Series B).
This complexity is why a simple "DCF" model often fails, and why you need an expert in Startup Valuation to get it right.
What are the Common Valuation Methods for CCPS?
Valuing complex financial instruments like CCPS is not a one-size-fits-all problem. A professional valuer often uses a combination of methods.
1. The Option Pricing Model (OPM)
This is a very common method, especially in the US for 409A Valuation (the equivalent of startup valuation for tax purposes).
The OPM (often using the Black-Scholes model) treats all shares (CCPS and equity) as "call options" on the company's total value. It's a sophisticated model that's excellent at "what-if" analysis for complex cap tables with multiple share classes.
2. The Probability-Weighted Expected Return Method (PWERM)
PWERM is more intuitive. It's the gold standard for Complex Financial Instrument Valuation.
Instead of a single "guess," the valuer models out several possible future scenarios for the company:
- Scenario 1: High-growth IPO
- Scenario 2: Strategic sale (M&A)
- Scenario 3: A "down round" or stagnation
- Scenario 4: Liquidation / Bankruptcy
Each scenario is given a probability (e.g., 20% chance of IPO). The valuer then calculates the payout for CCPS holders in each scenario and blends them into a single "probability-weighted" value today.
3. The Current Value Method (CVM)
This is the simplest model, sometimes used for very early-stage companies or when conversion is imminent. It essentially assumes an immediate conversion and values the CCPS based on the equivalent number of equities of shares today.
The Problem: The CVM completely ignores the valuable downside protection (liquidation preference) that CCPS holders have, so it often undervalues them.
Our Approach at My Valuation: We typically use PWERM or a hybrid "waterfall" analysis, as it most accurately captures the real-world rights and economics defined in your shareholders' agreement.
Why is Accurate CCPS Valuation Crucial for Compliance?
Getting your CCPS valuation right isn't just for negotiating with investors. It's a critical legal and financial requirement.
What are the rules for CCPS under FEMA?
When a foreign investor subscribes to CCPS, the Valuation under FEMA / FDI is mandatory.
The price of the CCPS must be at or above the fair market value as determined by a certified valuer (like an IBBI-Registered Valuer). If you underprice the shares, you could be in non-compliance with RBI regulations, leading to significant penalties.
How does CCPS affect Financial Reporting (Ind AS)?
Under Indian Accounting Standards (Ind AS), CCPS is a complex instrument that often has to be "bifurcated" - split into its debt and equity components on the balance sheet.
Companies are required to report the fair value of these instruments in their financial statements, which means you need a valuation not just at the time of investment, but potentially every reporting period.
How does CCPS impact ESOP Valuation?
This is a big one. When you issue ESOPs to your employees, you are giving them common equity.
To price those ESOPs fairly, you must first determine the value of the underlying equity. But the value of that equity is directly impacted by the "overhang" of the CCPS liquidation preference.
An accurate ESOP Valuation must account for the CCPS. Failing to do so can mislead your employees and create serious tax complications.
Don't Guess Your Valuation: Get Expert Help
Compulsory Convertible Preference Shares are a powerful tool for building a company. They align investor and founder interests and pave the way for growth.
But their complexity is their biggest risk. A "back-of-the-napkin" valuation simply doesn't work. A mistake in your CCPS valuation can derail a funding round, create tax liabilities, and cause massive dilution down the line.
At My Valuation, we are experts in navigating the complexities of startup finance. Our team of IBBI-Registered Valuers provides defensible, accurate valuations for everything from your first seed round to your pre-IPO ESOPs.
- Raising a new round? Contact our valuers for a consultation on structuring and pricing your round.
- Need compliance? Explore our services for Valuation under FEMA and Financial Reporting.
