6 min read · By Viren Makwana
Very few private investments in India are made in plain ordinary shares. Most use instruments that sit between debt and equity: preference shares and debentures that pay a return or rank ahead of founders today, and convert into equity later. Understanding these “quasi-equity” instruments helps founders negotiate better terms and helps investors see what protection they are really getting.
Ordinary equity
Equity shares carry voting rights and a share of profits through dividends, and they rank last if the company is wound up. They are simple and fully aligned with the founders, but they give the investor no special protection. That is why institutional investors rarely use them on their own.
The main quasi-equity instruments
| Instrument | How it ranks | How the investor earns | Converts into equity? | Typically used by |
|---|---|---|---|---|
| Compulsorily convertible preference shares (CCPS) | Ahead of equity shares for dividends and in liquidation | A small fixed dividend, a liquidation preference and the upside on conversion | Yes, mandatorily, at a pre-agreed ratio | Venture capital and private equity funds |
| Compulsorily convertible debentures (CCDs) | As a creditor until conversion | Interest until conversion, then equity upside | Yes, mandatorily | Investors who want interest income and a path to equity |
| Optionally convertible debentures (OCDs) | As a creditor | Interest and redemption premium, or conversion if the equity is worth more | At the investor’s option | Structured credit and real estate funds |
| Optionally convertible preference shares | Ahead of equity shares | Dividend and redemption, or conversion | At the holder’s option | Promoter-friendly growth deals |
Why investors prefer them
- Downside protection. A liquidation preference returns the investor’s money, sometimes with a minimum return, before ordinary shareholders receive anything in a sale.
- Valuation flexibility. The conversion ratio can adjust if later rounds are priced lower (anti-dilution) or if the company misses agreed targets.
- Income before exit. Debentures can pay interest while the business grows.
Why founders may accept them
- They can support a higher headline valuation, because the investor’s downside is protected.
- Interest on debentures is usually tax-deductible for the company.
- Conversion terms tied to performance can reward founders who hit their targets.
The fine print that matters
Conversion terms. Check the ratio, what adjusts it, and when conversion happens. A full-ratchet anti-dilution clause can hand investors a much larger stake after a down round than a weighted-average clause would.
Liquidation preference. “1x non-participating” returns the investment or converts to equity, whichever is higher. “Participating” preferences return the money and then share in the rest, which can take a large slice of a modest exit.
Foreign investors. Under India’s foreign investment rules, only fully and mandatorily convertible instruments count as equity. Their conversion price or formula must be fixed upfront and cannot be below fair value at issue. Optionally convertible instruments from foreign investors are treated as debt and follow external commercial borrowing rules.
Redemption pressure. Optionally convertible instruments that are not converted must be repaid, with any premium. Model that cash outflow under a downside case.
Choosing the right instrument
For an early-stage company raising from venture investors, CCPS is the market standard. For a profitable business with assets that wants to limit dilution, OCDs or CCDs with a coupon can be a better fit. For real estate projects, structured debentures with a share of surplus are common.
The instrument is part of the price. Two term sheets at the same valuation can mean very different outcomes for founders once preferences, ratchets and redemption terms are counted. Model the exit waterfall at several outcomes before you agree.
This article is for general information only and is not investment, legal or tax advice, or an offer or solicitation to buy or sell any security or fund units. Figures are drawn from public sources as of the date shown and may change. Speak to a qualified adviser before making any investment decision.