Convertible Debt: A Hybrid Financing Instrument in India

What is Convertible Debt?

Convertible debt is a hybrid financial instrument that starts as a loan but includes an option to convert it into equity at a future date or upon meeting certain predefined conditions, such as achieving a valuation milestone or securing additional funding.

Why is Convertible Debt Relevant in India?

India’s startup ecosystem is booming, and SMEs are increasingly seeking innovative financing solutions. Convertible debt has gained traction because it:

• Delays equity dilution, preserving ownership.
• Attracts investors who value both debt security and future equity potential.
• Aligns with the growth trajectory of early-stage and high-growth businesses.

Key Features of Convertible Debt

• Debt Component: Provides immediate capital with repayment terms or interest.
• Equity Conversion Option: Converts into equity based on predefined terms.
• Customizable Terms: Tailored to business needs.
• Investor Flexibility: Balances debt security with equity upside.

Types of Convertible Debt Instruments in India

• Fully Convertible Debentures (FCDs): Entire loan converts into equity after a specific period.
• Partially Convertible Debentures (PCDs): A portion converts into equity; the rest remains debt.
• Compulsorily Convertible Debentures (CCDs): Conversion into equity upon reaching predefined milestones.

Advantages of Convertible Debt

• Preservation of Ownership: Delays equity dilution until higher valuation rounds.
• Cost-Effective Financing: Lower interest rates than traditional loans.
• Flexible Terms: Tailored to mutual benefit.
• Supports Growth: Funds scaling operations without immediate repayment strain.

Convertible Debt vs. Traditional Debt and Equity