What is a Compulsory Convertible Preferred Share (CCPS)?
A Compulsory Convertible Preferred Share i.e CCPS involves the conversion of shares into a fixed number of common shares after a predetermined date. The value of a CCPS depends on the performance of the equity share. It constitutes the preferred stock of companies that use it for fundraising purposes. It allows shareholders to take part in share price appreciation in exchange for a typically lower dividend.
Let us consider the example of a convertible preferred share priced at USD 100 with a conversion ration of five. It refers to the fact that the common stock must trade above USD 20 for the conversion to be worthwhile for the investor. The conversion turns exciting with a rise in the equity shares.
So, if the common shares escalate to USD 25, the preference shareholders get USD 125 for each USD 100 preferred share. This refers to a 25% gain if the investor converts and sells the equity stock at USD 25.
Now, here there’s a disadvantage as well, and that is when the investor turns into equity shareholder, despite the uncertainties in the stock price. In the case, the price falls to USD 15 after the conversion, and the investor doesn’t sell at USD 25, the situation will even worsen.
So, in this case, they will own USD 75 in equity shares for every preferred (USD 100) stock, and they won’t get the fixed dividend or claim on the assets.
Optionally investors can opt for Optionally Convertible Preference Shares (OCPS) where investor get an option to convert the preference shares to either equity or not. OCPS also can have some options from Companies i.e. put or call option.
Valuation of Optionally Convertible Preference Shares require some different methodologies like option pricing model, etc.
Usual Model of Convertible Note:
The CN shall convert into Equity Shares based on a price per share (“Conversion Price”) arrived as per the formula below:
Discount Price = (Price per Security issued in the Qualified Equity Financing)*Discount Rate “Discount Rate” = (100 – X) %, expressed as a percentage.
X = [!]% up to a period of 12 months from the Closing Date
X = [!]% as increased by [!]% for every completed month from the 13th month from the Closing Date OR X = [!]% where Qualified
Financing Round is between 13 – 18 months of Convertible Note.
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