What Is Convertible Preferred Stock / Convertible Preference Shares

Convertible preference shares are a hybrid financial instrument that combines the benefits of preferred shares and equity shares. They offer investors a fixed dividend initially but can be converted into common equity shares after a specific period or under certain conditions.

This feature makes convertible preference shares a strategic instrument, allowing companies to raise flexible capital while offering investors a balance of stable income and potential for capital appreciation.

Convertible preference shares are preferred shares that give the holder an option to convert them into a predetermined number of ordinary (equity) shares.

These shares typically provide:

• A fixed dividend before conversion.
  

• Priority in dividend payments over equity shareholders.
  

• The right to participate in profits after conversion, similar to common shareholders.

They bridge the gap between debt and equity, offering both stability and potential capital appreciation.

Convertible preference shares possess distinct traits that make them attractive to both investors and issuing companies:

• Fixed Dividend: Investors receive a steady dividend before conversion.
  

• Conversion Option: Can be converted into equity shares after a defined period or at the investor’s discretion.
  

• Predetermined Conversion Ratio: Specifies how many equity shares each preference share converts into.
  

• Priority Rights: Holders are paid dividends and liquidation proceeds before ordinary shareholders.
  

• Limited Voting Rights: Generally, voting rights apply only under specific conditions (e.g., non-payment of dividends).
  

• Capital Appreciation: Post-conversion, investors can benefit from the rise in share prices.

These features make convertible shares a flexible financing option with risk-adjusted returns.

Here’s how the process generally unfolds:

1. Issuance: The company issues preference shares with a fixed dividend and a conversion option.
   

2. Holding Period: Investors receive dividends periodically during the pre-conversion phase.
   

3. Conversion Trigger: After the specified date or event (like IPO or performance milestone), shares are converted into equity at a set ratio.
   

4. Post-Conversion: Holders become ordinary shareholders, gaining voting rights and exposure to market fluctuations.

Example:

If a company issues 1,000 convertible preference shares at ₹100 each, convertible into 10 equity shares per unit after 3 years, an investor will receive 10,000 equity shares upon conversion.

Example 1:
A company issues preference shares at ₹1,000 each with a 6% annual dividend and converts them into 10 equity shares after five years.

Investors earn ₹60 annually until conversion, after which they participate in equity profits.

Example 2:

In India, startups often use CCPS when attracting venture capital. It helps investors lock in dividend income initially and then share in future equity growth when the company scales.

• Dividends received before conversion are typically taxable as income.
  

• Conversion itself is not a taxable event, but capital gains tax may apply if shares are later sold at a profit.
  

• Valuation depends on dividend yield, conversion ratio, company performance, and prevailing market rates.

Professional valuation ensures that both investors and issuers maintain transparency in pricing.

Convertible preference shares are a versatile financing instrument that bridge the gap between debt and equity, catering to both corporate and investor objectives. They offer companies flexible funding options while providing investors with stable income and potential capital appreciation.

Key highlights include:

• They combine the security of fixed dividends with the upside of equity participation.
  

• They enhance a company’s ability to attract diverse investor groups.
  

• They suit investors seeking a balanced mix of safety, steady returns, and long-term growth potential.

This content is for informational purposes only and the same should not be construed as investment advice. Bajaj Finserv Direct Limited shall not be liable or responsible for any investment decision that you may take based on this content.