How to Structure a CCPS Investment in an Indian Startup: Term Sheet, Valuation, and Regulatory Compliance

Kaustav Chowdhury
6 days ago
9 min read

Compulsorily Convertible Preference Shares (CCPS) have become the default instrument for venture capital and private equity investments in Indian startups. Unlike ordinary equity, CCPS offer investors a layer of downside protection through liquidation preference and anti-dilution rights while automatically converting into equity shares upon a specified trigger event. For foreign investors, CCPS carry a further advantage: the Foreign Exchange Management (Non-Debt Instruments) Rules, 2019 classify CCPS as equity instruments, allowing inbound investment under the automatic route without requiring prior RBI approval in most sectors.

This guide walks founders, investors, and legal practitioners through the entire process of structuring a CCPS investment in an Indian startup, from the Companies Act framework and FEMA pricing requirements to term sheet negotiation, valuation mechanics, and post-allotment ROC filings.

1. Legal Framework Under the Companies Act, 2013

Section 43 of the Companies Act, 2013 authorises companies limited by shares to issue two classes of shares: equity shares and preference shares. While the Act does not separately define CCPS as a distinct category, they fall within the broader category of preference shares under Section 43(b), read with Section 55. The defining characteristic of CCPS is the mandatory conversion obligation: unlike optionally convertible or redeemable preference shares, CCPS must convert into equity shares upon the occurrence of a specified event or the expiry of a stated period.

Section 55 of the Companies Act governs the issuance and redemption of preference shares. It prescribes a maximum tenure of 20 years for redemption, with an extended period of up to 30 years for infrastructure companies as notified by the Central Government. Since CCPS are compulsorily convertible rather than redeemable, the 20-year outer limit effectively serves as the maximum window within which conversion must occur. Most startup term sheets specify a conversion window of 10 to 15 years, well within this statutory ceiling.

The issuance of CCPS to external investors is treated as a further issue of share capital under Section 62(1)(c), requiring a special resolution passed by shareholders. For private placements, the company must also comply with Section 42 of the Act and Rules 13 and 14 of the Companies (Share Capital and Debentures) Rules, 2014. The private placement offer letter (Form PAS-4) must be issued to identified persons, with a cap of 200 persons per financial year (excluding qualified institutional buyers). The board meeting approving the CCPS issuance must be convened with proper notice, quorum, and agenda as prescribed under Secretarial Standard SS-1.

A critical prerequisite is the authorisation in the company's Articles of Association (AoA). If the AoA does not permit the issuance of preference shares or CCPS, the articles must be amended by special resolution before proceeding. Additionally, the authorised share capital must be sufficient to accommodate both the CCPS at issuance and the equity shares into which they will convert.

2. FEMA NDI Rules: Pricing Floor for Foreign Investors

When a CCPS round involves a non-resident investor, the FEMA (Non-Debt Instruments) Rules, 2019 impose a pricing floor. Rule 21 mandates that the issue price of equity instruments (including CCPS) to a person resident outside India must not be less than the fair market value (FMV) determined using any internationally accepted pricing methodology, on an arm's length basis, and duly certified by a prescribed professional.

For unlisted companies (which most startups are), the valuation must be carried out by a SEBI-registered Category I Merchant Banker or a Chartered Accountant using methods such as the Discounted Cash Flow (DCF) method, Net Asset Value (NAV) method, or comparable transaction multiples. The valuation certificate has a validity of 90 days from the date of issuance, so founders should plan their allotment timeline to fall within this window.

Once CCPS are allotted to a non-resident, the company must file Form FC-GPR with the Reserve Bank of India within 30 days of allotment through the authorised dealer bank. The FC-GPR filing must include the CCPS valuation certificate, KYC documents of the foreign investor, board and shareholder resolutions, and the Foreign Inward Remittance Certificate (FIRC) confirming receipt of funds.

It is important to note that sectoral caps and entry routes under the FDI policy apply equally to CCPS investments. If the startup operates in a sector requiring government approval (such as defence, broadcasting, or multi-brand retail), prior approval from the Department for Promotion of Industry and Internal Trade (DPIIT) must be obtained before allotment.

3. Rule 11UA Valuation for Income Tax Compliance

In addition to the FEMA pricing floor, the company must ensure that the CCPS issuance price complies with Rule 11UA of the Income Tax Rules, 1962. This rule prescribes the methodology for determining the fair market value of unquoted equity shares and CCPS. The CBDT notified the amended Rule 11UA through Notification No. 81/2023 dated September 25, 2023, introducing separate valuation mechanisms for CCPS.

Under the amended Rule 11UA, the FMV of CCPS may be determined using the DCF method, and founders now have the option to adopt the FMV of unquoted equity shares as a proxy for determining the FMV of CCPS. For investments by non-resident investors, five additional valuation methods are available: the Comparable Company Multiple Method, the Probability Weighted Expected Return Method, the Option Pricing Method, the Milestone Analysis Method, and the Replacement Cost Method.

A safe harbour provision of 10% has been introduced for both resident and non-resident investments. This means that if the actual issue price deviates from the FMV by up to 10%, the transaction will not attract adverse tax consequences under Section 56(2)(viib) (commonly known as the "angel tax" provision). However, it is worth noting that the Finance Act 2024 exempted non-resident investors from the angel tax altogether, effective from Assessment Year 2025-26 onwards.

The valuation report for Rule 11UA purposes must be obtained no more than 90 days before the date of allotment, consistent with the FEMA requirement. Founders should coordinate with their valuers to produce a single report that satisfies both Rule 11UA and FEMA Rule 21 requirements, avoiding duplication and inconsistency.

4. SEBI AIF Regulations for Fund Investors

When the investor is an Alternative Investment Fund (AIF) registered under the SEBI (Alternative Investment Funds) Regulations, 2012 (as amended in April 2026), additional compliance layers apply. Category I AIFs (including venture capital funds) and Category II AIFs (including private equity funds) are the most common investors in startup CCPS rounds.

SEBI now requires Category II AIFs to obtain independent valuations from SEBI-registered valuers at least semi-annually, using standardised methodologies for illiquid assets such as unlisted equity and CCPS. The AIF's investment committee must approve the CCPS terms, and the fund's Private Placement Memorandum (PPM) must disclose the types of instruments in which the fund may invest, including CCPS.

For Foreign Venture Capital Investors (FVCIs) registered with SEBI, investments in CCPS of eligible Indian venture capital undertakings can be made at a freely negotiated price, without being subject to the FEMA pricing floor. This is a significant advantage for early-stage investments where DCF-based valuations may be challenging to justify.

5. Term Sheet Essentials: Key Economic and Governance Terms

The term sheet is the commercial blueprint of the CCPS investment. While typically non-binding (except for exclusivity and confidentiality clauses), the term sheet sets the parameters for the definitive agreements, including the Share Subscription Agreement (SSA) and Shareholders' Agreement (SHA). The following terms require careful negotiation.

Conversion Ratio and Trigger Events

The conversion ratio determines how many equity shares each CCPS will convert into. In the simplest scenario, the ratio is 1:1, meaning each CCPS converts into one equity share. However, anti-dilution adjustments, bonus issues, or stock splits may alter this ratio over time. Common conversion triggers in Indian startup deals include a qualifying IPO (typically at a minimum valuation threshold), an acquisition or change of control event, a subsequent funding round at or above a specified valuation, or the expiry of a longstop date (usually 10 to 15 years from issuance).

Anti-Dilution Protection

Anti-dilution clauses protect investors if the company issues shares in a future round at a price lower than the CCPS round price (a "down round"). The two primary mechanisms are broad-based weighted average (BBWA) and full ratchet. BBWA is the market standard and adjusts the conversion price downward by factoring in the size of the down round relative to the total share count. Full ratchet, which reprices the investor's CCPS to the lower round price regardless of the size of dilution, is significantly more aggressive and can severely dilute founder ownership. Founders should resist full ratchet and insist on BBWA, with carve-outs for ESOP issuances and other exempted events.

Liquidation Preference

Liquidation preference determines the order and quantum of payouts on a liquidity event (acquisition, winding up, or deemed liquidation). The market standard for good-faith investments is a 1x non-participating preference, where the investor receives either the return of invested capital or the pro-rata share of exit proceeds on an as-converted basis, whichever is higher. A participating preference, where the investor receives both the preference amount and a pro-rata share of remaining proceeds, is more investor-friendly and should be carefully evaluated by founders.

The definition of "liquidation event" is critical. Most term sheets extend it beyond statutory winding up to include acquisitions, mergers, slump sales, exclusive licensing of substantially all IP, and schemes of arrangement under Sections 230 to 232 of the Companies Act.

Board Composition and Protective Rights

Investors typically negotiate the right to appoint a nominee director on the company's board. A balanced board structure, with founder seats equal to investor seats plus one or two independent directors, preserves operational flexibility. An investor-majority board from the seed stage is generally viewed as a red flag. Protective provisions (or "affirmative vote" rights) typically require investor consent for certain reserved matters such as alteration of share capital, changes to the AoA, related party transactions, creation of charges or security interests on company assets, and approval of annual budgets exceeding a threshold.

6. Definitive Agreements: SSA and SHA

Once the term sheet is signed, the parties proceed to negotiate the definitive agreements. The Share Subscription Agreement (SSA) documents the subscription terms, including the number of CCPS, the subscription price per share, conditions precedent to closing, representations and warranties of the company and founders, and indemnification provisions. The SSA typically contains a schedule setting out the conversion mechanics, including the formula for computing the adjusted conversion ratio.

The Shareholders' Agreement (SHA) governs the ongoing relationship between the founders and the investors. Key SHA provisions include transfer restrictions (right of first refusal, tag-along, drag-along), information rights (monthly and quarterly reporting obligations), pre-emptive rights on new issuances, and founder lock-in and non-compete obligations. In transactions involving a CCI merger control notification threshold being met, the investment cannot be consummated until CCI approval is obtained.

7. Post-Allotment ROC Filings and Compliance

After the CCPS are allotted, the company must complete several filings with the Registrar of Companies (ROC) within prescribed timelines. Failure to comply with these deadlines can attract penalties under Section 454 of the Companies Act.

MGT-14 (Registration of Special Resolution): Must be filed with the ROC within 30 days of passing the special resolution authorising the CCPS issuance. This form records the registration of the special resolution under Section 117 of the Companies Act. The PAS-4 private placement offer letter should be issued only after MGT-14 has been filed.
PAS-3 (Return of Allotment): Must be filed within 30 days from the date of allotment of CCPS. This form provides the ROC with details of the allotment, including the number of shares allotted, the consideration received, and the names and addresses of allottees.
SH-1 (Share Certificate): The company must issue share certificates in Form SH-1 within two months of allotment, signed by at least two directors or one director and the Company Secretary. For CCPS, the share certificate should clearly state the class of shares, the dividend rate, the conversion terms, and any other rights attached to the CCPS.

In addition to these filings, the company must update the Register of Members under Section 88, maintain a separate register of preference shareholders, and ensure that the annual return (Form MGT-7) accurately reflects the CCPS in the share capital structure.

8. Tax Treatment on Conversion

Under Section 47(xb) of the Income Tax Act, 1961 (now carried forward into the Income Tax Act, 2025), the conversion of CCPS into equity shares is not treated as a transfer and does not attract capital gains tax. This is a significant advantage of the CCPS structure. The cost of acquisition of the resulting equity shares is deemed to be the cost at which the CCPS were originally acquired, and the holding period of the CCPS is included in the holding period of the equity shares for the purpose of determining whether gains on a subsequent sale are long-term or short-term.

9. Practical Considerations and Common Pitfalls

Several practical issues frequently arise during CCPS transactions. Founders should pay attention to the following areas.

Authorised Capital Sufficiency: Ensure the authorised capital covers both the CCPS at issuance and the equity shares post-conversion. An increase in authorised capital requires a special resolution and payment of additional ROC fees.
Dividend Rights: CCPS holders are entitled to preferential dividends as specified in the terms of issue. The dividend rate and whether it is cumulative or non-cumulative must be clearly documented.
Voting Rights: Under Section 47(2) of the Companies Act, preference shareholders have a right to vote only on resolutions that directly affect their rights (such as a variation of rights under Section 48 or a winding-up resolution). They do not have general voting rights on all resolutions unless the company has failed to pay dividends for two consecutive years.
Stamp Duty: The issuance of CCPS is subject to stamp duty under the Indian Stamp Act, 1899. Rates vary by state, and the stamp duty is typically borne by the company.
Allotment Timeline: Funds received through private placement must be kept in a separate bank account and cannot be utilised until allotment is made. Allotment must be completed within 60 days of receipt of funds, failing which the company must return the money within 15 days with interest at 12% per annum.

Conclusion

Structuring a CCPS investment in an Indian startup requires careful coordination across multiple regulatory frameworks: the Companies Act for corporate authorisation and issuance mechanics, FEMA for foreign investment pricing and reporting, the Income Tax Rules for valuation compliance, and SEBI regulations for institutional fund investors. The term sheet negotiation must balance investor protection (through liquidation preference, anti-dilution, and board rights) with founder flexibility (through BBWA anti-dilution, non-participating preferences, and balanced governance structures). By understanding each of these components, founders and investors can structure transactions that are both commercially sound and fully compliant with Indian law.