Issue of Convertible Debt Instruments and Warrants
PART II: ISSUE OF CONVERTIBLE DEBT INSTRUMENTS AND WARRANTS
Regulation 9. Eligibility requirements for issue of convertible debt instruments
An issuer is eligible to make an Initial Public Offer (IPO) of Convertible Debt Instruments (CDIs).
The issuer is not required to first make an IPO of its equity shares.
The issuer is also not required to have its equity shares already listed on a recognised stock exchange.
Therefore, an IPO of Convertible Debt Instruments can be made independently, even if the issuer is an unlisted company.
This enables companies to raise capital from the public through convertible debt instruments without first becoming a listed equity company.
The issuer must, however, satisfy the prescribed condition regarding its existing public debt obligations.
The issuer must not have defaulted in:
Payment of interest.
Repayment of the principal amount
in respect of any debt instruments previously issued to the public.
The default, if any, must not have continued for a period exceeding six months.
If the issuer has remained in default for more than six months, it is not eligible to make an IPO of Convertible Debt Instruments.
Regulation 10. Additional requirements for issue of convertible debt instruments
10(1).
(a).
An issuer making an Initial Public Offer (IPO) of Convertible Debt Instruments (CDIs) must comply with all the general requirements prescribed under the ICDR Regulations.
In addition to those general requirements, the issuer must also satisfy certain additional conditions specifically applicable to IPOs of Convertible Debt Instruments.
One such mandatory condition is that the issuer must obtain a credit rating.
The credit rating must be obtained from at least one recognised Credit Rating Agency (CRA).
The purpose of the credit rating is to provide an independent assessment of the issuer's ability to meet its debt obligations, such as:
Payment of interest.
Repayment of the principal amount.
(b).
An issuer making an Initial Public Offer (IPO) of Convertible Debt Instruments (CDIs) must appoint at least one Debenture Trustee.
The appointment of the Debenture Trustee is mandatory before issuing the Convertible Debt Instruments to the public.
The Debenture Trustee must be appointed in accordance with:
The Companies Act, 2013, and
The SEBI (Debenture Trustees) Regulations, 1993.
A Debenture Trustee is an independent person or entity appointed to protect the interests of the debenture holders.
The Debenture Trustee acts as a representative of all investors holding the Convertible Debt Instruments.
The Debenture Trustee is responsible for:
Monitoring compliance with the terms of the debenture issue.
Ensuring that the issuer fulfils its obligations towards investors.
Taking appropriate action if the issuer defaults in payment of interest, repayment of principal, or breaches the terms of the issue.
Safeguarding the rights and interests of the debenture holders throughout the tenure of the instruments.
(c).
An issuer making an Initial Public Offer (IPO) of Convertible Debt Instruments (CDIs) must create a Debenture Redemption Reserve (DRR).
The Debenture Redemption Reserve must be created in accordance with:
The Companies Act, 2013, and
The rules made thereunder.
A Debenture Redemption Reserve (DRR) is a reserve created out of the company's profits for the purpose of redeeming debentures when they become due for repayment.
The reserve acts as a financial safeguard, ensuring that sufficient funds are available to meet the issuer's redemption obligations.
The creation and maintenance of the DRR must comply with the provisions of the Companies Act, 2013 and the applicable rules.
Debenture Redemption Reserve
Imagine a company borrows money from the public by issuing debentures.
Investors give the company money today.
The company promises to:
Pay periodic interest.
Repay the principal amount on the maturity date.
To ensure the company does not spend all its profits and later claim it has no money to repay investors:
The law requires it (where applicable) to set aside a portion of its profits into a separate reserve called the Debenture Redemption Reserve (DRR).
(d).
If the issuer proposes to issue secured Convertible Debt Instruments (CDIs), it must create an appropriate charge or security over its assets in favour of the debenture holders.
The assets offered as security must satisfy the following conditions:
(i). Assets must be sufficient to discharge the principal amount
The value of the secured assets must be adequate to cover the principal amount payable under the Convertible Debt Instruments.
The asset value should remain sufficient at all times during the tenure of the instruments.
This ensures that, if the issuer defaults, the secured assets are capable of repaying the principal amount due to investors.
(ii). Assets must be free from any encumbrance
The assets proposed to be offered as security should be free from any encumbrance.
An encumbrance means any existing legal claim, charge, mortgage, lien, pledge, or other right created in favour of another person over the asset.
Investors should receive security over assets that are not already burdened by conflicting rights, unless permitted under clause (iii).
(iii). Consent for second or pari passu charge must be obtained
If the assets are already charged in favour of:
An existing lender,
A security trustee, or
The proposed security is to be created over leasehold land,
the issuer must obtain the necessary consent before creating security for the Convertible Debt Instruments.
The consent must be obtained from:
The existing lender,
The existing security trustee, or
The lessor, as the case may be.
The consent must permit the creation of either:
A second charge.
A pari passu charge over the assets.
Such consent must be submitted to the Debenture Trustee before the opening of the issue.
Second charge means the new lender's security ranks after an existing first charge.
Pari passu charge means two or more lenders have equal ranking over the same secured asset and share the security proportionately.
(iv). Asset cover to be calculated after considering prior charges
If the Convertible Debt Instruments are secured by a second or subsequent charge, the asset cover must be calculated after deducting liabilities secured by the first or prior charge.
The issuer cannot consider the entire value of the secured asset while calculating the security available to the debenture holders.
Only the remaining value of the asset, after accounting for liabilities having a superior charge, can be considered as security for the Convertible Debt Instruments.
10(2).
The issuer is required to redeem the Convertible Debt Instruments (CDIs) strictly in accordance with the terms specified in the Offer Document.
The Offer Document contains the conditions governing the issue, including:
Maturity period.
Redemption date.
Redemption amount.
Conversion terms, if applicable.
Interest payment terms.
Any other rights and obligations of the issuer and the investors.
The issuer must honour all the redemption terms exactly as disclosed in the Offer Document.
The issuer cannot unilaterally change the redemption terms after the issue, unless permitted by law and in accordance with the applicable regulations.
Redemption may take place by:
Repayment of the principal amount, or
Conversion into equity shares, if the terms of the Convertible Debt Instruments so provide.
Example:
ABC Ltd. issues 5-year Convertible Debentures.
The Offer Document provides that:
Interest will be paid annually.
At the end of five years, the debentures will either be redeemed at face value or converted into equity shares, depending on the terms of the issue.
ABC Ltd. must redeem or convert the debentures exactly in accordance with these disclosed terms.
Regulation 11. Conversion of optionally convertible debt instruments into equity shares
11(1).
The issuer cannot convert the Optionally Convertible Debt Instruments into equity shares without the holder's express consent.
Each holder must give positive consent to the issuer for the conversion.
Positive consent means an affirmative and explicit approval by the holder, such as:
Signing a consent form.
Sending a written confirmation.
Approving the conversion through any prescribed mode.
The issuer must send a notice to the holders seeking their consent for conversion.
The holder is free to:
Consent to the conversion, or
Decline the conversion, in accordance with the terms of the issue.
Silence does not amount to consent.
If a holder does not reply to the notice sent by the issuer, the issuer cannot assume that the holder has agreed to the conversion.
Non-receipt of a reply from the holder must not be construed as consent for converting the Optionally Convertible Debt Instruments.
The issuer must obtain an affirmative response before converting the debt instruments into equity shares.
Example:
ABC Ltd. issues Optionally Convertible Debentures (OCDs) to 100 investors.
After three years, ABC Ltd. decides to convert the OCDs into equity shares.
The company sends a conversion notice to all 100 investors seeking their consent.
The responses received are:
70 investors send written consent agreeing to the conversion.
20 investors expressly refuse the conversion.
10 investors do not respond.
ABC Ltd. can convert only the OCDs held by the 70 investors who have given positive consent.
The OCDs held by the 20 investors who refused and the 10 investors who did not respond cannot be converted into equity shares, since non-receipt of a reply is not deemed to be consent.
11(2).
Option Not to Convert Convertible Debt into Equity
If an issuer has issued listed convertible debt instruments:
The convertible portion of these debt instruments must have a value exceeding ₹10 crore.
At the time of making the issue, the issuer must not have determined the conversion price of the convertible debt instruments.
In such a case, the holders of the convertible debt instruments must be given an option.
The option allows the holders to choose not to convert the convertible portion of their debt instruments into equity shares.
Convertible debt normally gives the holder a right to convert the debt into equity.
Essentially:
The convertible portion is more than ₹10 crore.
The conversion price has not been fixed at the time of issue, then the investor cannot be forced to convert the debt into equity.
The investor must be given the choice to opt out of conversion.
Example:
A company issues listed convertible debt instruments worth ₹15 crore.
The conversion price is not decided when the issue is made.
When the time for conversion comes, the holder must be given the choice:
Convert the convertible portion into equity shares.
Do not convert it into equity shares.
Conversion at Pre-Disclosed Upper Price Limit
The issuer is not required to give the holders an option to accept or reject the conversion of the Convertible Debt Instruments into equity shares if certain conditions are satisfied.
The following conditions must be fulfilled:
The issuer must have determined an upper limit on the conversion price at the time of making the issue.
The upper limit on the conversion price must be disclosed to the investors in the Offer Document.
The issuer must also disclose the justification for fixing that upper limit.
The upper limit means the maximum conversion price at which the Convertible Debt Instruments can be converted into equity shares.
Since investors are informed in advance of the highest possible conversion price, they invest with full knowledge of the maximum price at which conversion may occur.
Therefore, the issuer need not obtain a fresh option or consent from the holders at the time of conversion.
The exemption is available only if the actual conversion takes place at or below the disclosed upper limit.
If the issuer fixes the conversion price above the disclosed upper limit, this proviso does not apply, and the issuer cannot dispense with the requirement of giving the holders an option.
Example:
Step 1: Issue of Convertible Debentures
ABC Ltd. issues Listed Optionally Convertible Debentures.
The convertible portion is ₹20 crore.
Step 2: Upper Limit Disclosed
At the time of the issue:
The exact conversion price is not determined.
The Offer Document states that the maximum conversion price will not exceed ₹300 per share.
The company also explains why the upper limit of ₹300 has been fixed.
Step 3: Conversion Price Determined
Two years later, ABC Ltd. fixes the conversion price at ₹280 per share.
Step 4: Conversion
Since:
The upper limit (₹300) was determined and disclosed at the time of issue.
The justification for the upper limit was disclosed.
The actual conversion price (₹280) is within the disclosed upper limit.
ABC Ltd. is not required to seek the holders' option or consent before converting the debentures into equity shares.
Different Scenario
Suppose ABC Ltd. later fixes the conversion price at ₹320 per share.
Since ₹320 exceeds the disclosed upper limit of ₹300, the issuer cannot rely on this proviso, and the exemption from giving the holders an option will not be available.
11(3).
Under circumstances holders of Convertible Debt Instruments are required to be given an option whether or not to convert the instruments into equity shares under sub-regulation (2).
The conversion price must be determined in the general meeting of the shareholders.
Every holder is given the choice to:
Convert the Convertible Debt Instruments into equity shares at the approved conversion price, or
Decline the conversion.
If one or more holders do not exercise the option to convert, the issuer cannot force the conversion.
Instead, the issuer must redeem the convertible portion of the instruments held by those holders.
The redemption must be completed within one month from the last date specified for exercising the conversion option.
The redemption price cannot be less than the face value of the Convertible Debt Instruments.
The issuer may redeem the instruments at a price higher than the face value, but not below the face value.
Example:
Step 1: Issue of Convertible Debentures
ABC Ltd. issues Optionally Convertible Debentures having a face value of ₹1,000 each.
The holders are entitled to choose whether to convert the debentures into equity shares.
Step 2: Conversion Price Approved
The shareholders of ABC Ltd. approve a conversion price of ₹250 per equity share in the general meeting.
Step 3: Option Given to Holders
ABC Ltd. gives all debenture holders 30 days to decide whether they wish to convert.
Step 4: Investors Exercise Their Choice
Investor A chooses to convert the debentures into equity shares.
Investor B decides not to convert.
Step 5: Redemption
ABC Ltd. cannot compel Investor B to become a shareholder.
Instead, the company must redeem Investor B's debentures within one month from the last date for exercising the conversion option.
If the face value of each debenture is ₹1,000, the company must redeem it for at least ₹1,000 per debenture.
The company may redeem it for more than ₹1,000, if the terms of the issue so provide, but it cannot redeem it for less than the face value.
11(4).
The requirement of giving the holders an option to convert under 11(2) is not applicable where the redemption mechanism has already been disclosed in the Offer Document.
The Offer Document must clearly specify:
The circumstances in which the Convertible Debt Instruments will be redeemed.
The redemption procedure.
The redemption price.
The redemption timeline.
Any other relevant terms governing redemption.
Investors subscribe to the Convertible Debt Instruments after reviewing these disclosures.
Since the redemption terms are already known and accepted by the investors at the time of subscriptionL
The issuer is not required to separately offer the conversion option contemplated under 11(2).
The issuer must redeem the Convertible Debt Instruments strictly in accordance with the terms disclosed in the Offer Document.
The issuer cannot alter the redemption terms after the issue unless permitted under law and the applicable regulations.
Regulation 12. Issue of convertible debt instruments for financing
An issuer cannot issue Convertible Debt Instruments (CDIs) for the following purposes:
Financing any person who is part of the promoter group.
Providing loans to any person who is part of the promoter group.
Acquiring shares of any person who is part of the promoter group.
Financing any group company.
Providing loans to any group company.
Acquiring shares of any group company.
The restriction prevents an issuer from raising money from public investors and using those funds primarily for the benefit of its promoters or related group companies.
An exception is available where the issuer proposes to issue Fully Convertible Debt Instruments (FCDIs).
The issuer may use the proceeds for the above purposes only if:
The instruments are fully convertible.
The conversion period is less than 18 months from the date of issue.
If the conversion period is 18 months or more, the exception is not available, and the issuer cannot use the proceeds for:
Financing, lending to, or acquiring shares of promoter group entities or group companies.
Example:
Example 1 – Not Permitted
Step 1: Issue of Convertible Debentures
ABC Ltd. proposes to issue Optionally Convertible Debentures worth ₹100 crore.
Step 2: Proposed Use of Funds
₹60 crore is proposed to be lent to XYZ Pvt. Ltd., a company belonging to ABC Ltd.'s promoter group.
Step 3: Result
Since the proceeds are being used to provide a loan to a promoter group company, the proposed issue is not permitted under the regulation.
Example 2 – Exception Available
Step 1: Issue of Fully Convertible Debentures
ABC Ltd. issues Fully Convertible Debentures worth ₹100 crore.
Step 2: Conversion Period
The debentures will automatically convert into equity shares after 12 months.
Step 3: Proposed Use of Funds
A part of the proceeds is proposed to finance a group company.
Step 4: Result
Since:
The instruments are fully convertible.
The conversion period is less than 18 months.
ABC Ltd. can use the proceeds for financing the group company, and the exception under the proviso applies.
Example 3 – Exception Not Available
Step 1: Issue of Fully Convertible Debentures
ABC Ltd. issues Fully Convertible Debentures.
Step 2: Conversion Period
The debentures will convert into equity after 24 months.
Step 3: Proposed Use of Funds
The proceeds are proposed to be used for acquiring shares of a promoter group company.
Step 4: Result
Although the instruments are fully convertible, the conversion period exceeds 18 months.
Therefore, the exception is not available, and ABC Ltd. cannot use the proceeds for acquiring shares of the promoter group company.
Regulation 13. Issue of warrants
13
(a).
An issuer is permitted to issue warrants as part of an Initial Public Offer (IPO).
The issuer must comply with the conditions prescribed under the ICDR Regulations for issuing such warrants.
One of the mandatory conditions relates to the tenure of the warrants.
The tenure of the warrants cannot exceed 18 months from the date of their allotment in the IPO.
Tenure means the period during which the warrant holder has the right to exercise the warrant and obtain equity shares.
The 18-month period is counted from the date on which the warrants are allotted, and not:
The date of filing the offer document.
The date of opening of the IPO.
The date of listing of the warrants.
Once the tenure expires, the holder can no longer exercise the warrants, unless otherwise permitted under the terms of the issue and the applicable regulations.
Example:
Step 1: IPO
ABC Ltd. makes an IPO and issues 1 lakh warrants to investors.
Step 2: Allotment
The warrants are allotted on 1 January 2026.
Step 3: Calculate the Maximum Tenure
The maximum permissible tenure is 18 months from the date of allotment.
Therefore, the warrants must be exercisable on or before 30 June 2027.
Step 4: Compliance
If the warrants expire on 30 June 2027, the requirement is satisfied.
If ABC Ltd. issues warrants that are exercisable until 31 December 2027 (24 months from allotment):
The issue will not comply with the ICDR Regulations because the tenure exceeds the maximum limit of 18 months.
(b).
An issuer is permitted to issue warrants as part of an Initial Public Offer (IPO).
A warrant may be attached to a specified security issued in the IPO.
A specified security refers to the security with which the warrant is issued, such as an equity share or any other security permitted under the ICDR Regulations.
A single specified security may have one or more warrants attached to it.
So:
One security can carry multiple rights to subscribe to additional equity shares in the future.
Each warrant represents a separate right to apply for or receive equity shares in accordance with the terms of the issue.
The number of warrants attached to a specified security is determined by the issuer and disclosed in the Offer Document.
Investors purchasing the specified security receive the attached warrants along with it and may exercise them in accordance with the conditions of the issue.
Example
Step 1: IPO Structure
ABC Ltd. issues 1 Equity Share together with 2 Warrants.
Step 2: Subscription
Investor A subscribes to 100 Equity Shares
Step 3: Warrants Received
Since each equity share carries 2 Warrants, Investor A receives:
100 Equity Shares.
200 Warrants.
Step 4: Exercise of Warrants
If each warrant gives the holder the right to subscribe to one additional equity share, Investor A may later exercise:
200 Warrants, and
Receive 200 additional equity shares, subject to payment of the exercise price and compliance with the terms of the issue.
Thus, one specified security can have multiple warrants attached to it, each conferring a separate right to obtain equity shares in the future.
(c).
The issuer must determine the exercise price of the warrants upfront, before making the Initial Public Offer.
Instead of fixing a specific exercise price, the issuer may determine a formula for calculating the exercise price.
Whether the issuer fixes:
A specific exercise price.
A formula for determining the exercise price.
the same must be disclosed in the Offer Document.
Investors should know, at the time of subscribing, how much they will have to pay to exercise the warrants in the future.
The warrant holder is required to pay at least 25% of the total consideration amount upfront.
The consideration amount means the amount payable for acquiring the equity shares upon exercising the warrants.
The upfront payment demonstrates the investor's commitment and discourages speculative subscriptions.
The remaining consideration is payable at the time the warrant is exercised, in accordance with the terms of the issue.
Exercise Price
The exercise price is the price at which the holder of an option has the right to purchase the underlying security.
It is also commonly called the strike price.
The holder can exercise the option only at the predetermined exercise price, irrespective of the market price of the underlying security.
It is generally fixed or determined according to a formula specified in the terms of the issue.
Exercise Price and Upfront Payment
When the exercise price is determined using a formula:
The exact exercise price may not be known at the time of the issue.
In such cases, the issuer must calculate the 25% upfront consideration based on the cap price of the price band determined for the linked equity shares or convertible securities.
The cap price is the highest price in the price band disclosed for the issue.
This ensures that the upfront payment is calculated conservatively, based on the maximum possible exercise price.
Example 1 – Fixed Exercise Price
Step 1: Issue of Warrants
ABC Ltd. issues warrants in its IPO.
The Offer Document states: Exercise price = ₹200 per warrant.
Step 2: Upfront Payment
Consideration payable on exercise = ₹200.
Minimum upfront payment: 25% × ₹200 = ₹50 per warrant.
Step 3: Exercise
The investor pays ₹50 at the time of allotment.
The remaining ₹150 when exercising the warrant.
Since the exercise price was determined upfront and disclosed in the Offer Document, and at least 25% was received upfront, the requirement is satisfied.
Example 2 – Exercise Price Based on a Formula
Step 1: Issue of Warrants
ABC Ltd. states that the exercise price will be determined using a formula linked to the IPO price.
The Offer Document also specifies a price band of ₹180–₹220 for the linked equity shares.
Step 2: Determine Upfront Consideration
Since the exercise price is formula-based, the cap price of ₹220 is used for calculating the upfront payment.
Minimum upfront payment: 25% × ₹220 = ₹55 per warrant.
Step 3: Exercise
Even if the actual exercise price is later determined to be ₹200:
The investor must have already paid ₹55 upfront, because the regulation requires the upfront consideration to be calculated using the cap price, not the eventual exercise price.
(d).
The warrant holder is given a specified period to exercise the warrants and obtain equity shares.
The warrant holder must exercise the warrants within three months from the date of payment of the consideration.
Consideration refers to the amount paid by the warrant holder towards exercising the warrant and acquiring the equity shares.
If the warrant holder does not exercise the option to obtain equity shares within the prescribed three-month period, the warrants lapse in respect of that exercise.
In such a case, the consideration already paid by the warrant holder will be forfeited by the issuer.
Forfeiture means that:
The issuer retains the money already paid.
The warrant holder loses the right to claim a refund of that amount.
The warrant holder also loses the right to obtain equity shares against those warrants
Example
Step 1: Issue of Warrants
ABC Ltd. issues warrants in its IPO.
The exercise price of each warrant is ₹200.
Step 2: Payment of Consideration
Investor A decides to exercise 100 warrants.
On 1 January 2026, Investor A pays the required consideration.
Step 3: Time Limit for Exercise
Investor A must complete the exercise process and obtain the equity shares within three months from 1 January 2026.
Therefore, the last date for exercise is 31 March 2026.
Step 4: Failure to Exercise
Investor A does not exercise the warrants by 31 March 2026.
Step 5: Consequence
The amount already paid by Investor A is forfeited by ABC Ltd.
Investor A:
Does not receive the equity shares.
Cannot claim a refund of the consideration paid.
Loses all rights in respect of those warrants.
