When you incorporate, you and your co-founders hold ordinary equity shares. When a venture fund writes a priced cheque, it almost never buys those same shares. Instead, in India, it buys a different class called compulsorily convertible preference shares, or CCPS. Understanding why is one of the most useful things a first-time founder can learn, because it explains most of what you will later see in a term sheet.
Common equity versus preference shares
A company can issue more than one class of shares. The two that matter for you are:
- Equity (common) shares: the ordinary shares founders, employees (through ESOPs) and the company itself start with. They carry voting rights and full upside, but they sit last in line if the company is sold or wound up. Everyone else gets paid first, and founders share whatever is left.
- Preference shares: a class that ranks ahead of equity on two things the name points to, a preference on dividends and a preference on the proceeds if the company is liquidated or sold. Investors take this class precisely because it protects their money on the downside.
What "preference" buys the investor
The core protection is the liquidation preference. If the company is sold, preference holders get their agreed amount back before equity holders see anything. Alongside it, a CCPS instrument typically carries a negotiated bundle: a dividend right (often a nominal, non-cumulative rate in early rounds), anti-dilution protection, and specific governance and information rights. These sit on top of the shares until the moment they convert into ordinary equity.
Why the "compulsorily convertible" part matters
Plain preference shares create two problems in India that CCPS solve.
1. The Companies Act
Under Section 55 of the Companies Act, 2013, a company cannot issue irredeemable preference shares, and redeemable preference shares must be redeemed within 20 years of issue (up to 30 years for certain infrastructure companies), out of profits or a fresh issue. A startup burning cash cannot promise to buy shares back. CCPS avoid this entirely: they are not redeemed for money, they compulsorily convert into equity shares at a defined event or date, so the investor ends up as an ordinary shareholder rather than a creditor. Issuance follows Sections 42, 55 and 62 read with the Companies (Share Capital and Debentures) Rules, 2014.
2. FEMA and foreign capital
A large share of venture money in India is foreign. Under the Foreign Exchange Management (Non-Debt Instruments) Rules, 2019, only certain instruments count as equity instruments for foreign direct investment: equity shares, share warrants, and preference shares or debentures that are fully and compulsorily convertible. An optionally convertible instrument is treated as debt and falls under the stricter External Commercial Borrowing regime instead. So the "compulsorily" is not lawyer decoration. It is what lets an offshore fund invest as equity under FEMA. Such an issue is reported to the RBI in Form FC-GPR through your authorised dealer bank.
How and when CCPS converts
Each CCPS usually converts into one or more equity shares based on a conversion ratio fixed upfront at issuance. FEMA pricing rules require that the conversion formula be set at the time of issue and that the eventual conversion price is not lower than the fair value determined at issuance. Conversion is commonly triggered by a qualified IPO, a defined date, or by investor election. Until then the investor holds preference shares with all the protective rights above; after conversion those special rights fall away and they become an ordinary shareholder.
What this means for you as a founder
- Your cap table will show at least two classes: founder and ESOP equity, and one line of CCPS per priced round (Series Seed, Series A, and so on), often with slightly different terms.
- The economics you negotiate, especially the liquidation preference, live inside the CCPS terms, not the headline valuation. Read them together.
- Because CCPS convert to equity, your fully diluted ownership already assumes conversion. That is the number that governs control and future dilution, so always model your stake on a fully converted basis.
In short, CCPS is the market-standard priced-round instrument in India because it gives investors downside protection while staying compliant with both the Companies Act and FEMA, and it eventually turns into the same equity you hold.