Conversion Of Loan Into Equity A Smart financial Strategy

INTRODUCTION

In the dynamic landscape of corporate finance, companies often resort to debt funding as a strategic tool for expansion or sustenance. However, in circumstances necessitating financial restructuring or in pursuit of investor alignment, the conversion of such debt into equity becomes both a practical and tactical recourse.

Section 62(3) of the Companies Act, 2013, embodies this flexibility by enabling companies to convert loans or debentures into equity shares, subject to compliance with prescribed conditions, This provision not only facilitates capital restructuring but also ensures a balanced alignment of stakeholder interests through procedural safeguards and statutory oversight.

But how exactly does the process of conversion of loan into equity work? What Are The Regulations Outlined in the Companies Act, 2023 Governing This Transformation? Understanding these complexities can help business owners, investors, and financial professionals make informed decisions.

In this comprehensive guide, we will see into the intricacies of the conversion of loans to equity, guided by the provisions set under the Companies Act. We’ll discuss the pre-conversion considerations, through the step-by-step conversion process, into the implications post-conversion.

Why Convert a Loan into Equity?

There are several reasons for this financial move:

Part I: Understanding the Legal Framework

• Definition and Explanation of Relevant Terms: 

Before going through the legal framework, it’s crucial to understand the key terms involved. A loan refers to funds borrowed by a company from an individual, institution, or another entity, typically with an obligation to repay the borrowed amount with interest. Equity, on the other hand, represents ownership in a company, often in the form of shares or stock. Conversion refers to the process of converting a loan into equity, where the creditor becomes a shareholder in the company.

• Brief Introduction to the Companies Act and Section 62(3): 

The Companies Act, 2013 serves as the primary legislation governing the functioning and operations of companies. Section 62(3) of the Companies Act allows for the conversion of loans into equity. This section states that a company may, with the approval of a special resolution passed by its shareholders, convert any of its loans into shares of the company.

• Rules made under the Companies Act:

 The Companies (Share Capital and Debentures) Rules, 2014 (the “Rules”) play a significant role in providing further provisions and guidance regarding the conversion of loans into equity. These rules establish specific conditions that must be met for a loan to be converted into equity:

Part II: Pre-Conversion Considerations

In order for a loan to be converted into equity, the company must have passed a special resolution at the time of accepting the loan, which specifies that the loan may be converted into equity in the future. This is necessary to ensure that the lender is aware of the possibility of the loan being converted into equity, and that they have agreed to this possibility. The special resolution should specify the following:

1. The terms and conditions on which the loan may be converted into equity, such as the date on which the conversion will take place, the number of shares that will be issued in exchange for the loan, and the price per share.
2. The procedure for converting the loan into equity, such as the steps that the company and the lender must take in order to complete the conversion.
3. The special resolution must be passed by a majority of the company’s shareholders at a general meeting. Once the special resolution has been passed, the company may convert the loan into equity at any time in the future, subject to the terms and conditions specified in the resolution.

Part III: Procedure for Converting a Loan into Equity

1. Conduct of Board Meeting: A company shall convene a board meeting by giving atleast 7 days’ notice annexed with the agendas and other information required to be ascertain the reason of conducting of board meeting and prepared for it. Also the board of directors need to approve the notice of extra-ordinary general meeting for the approval of the members of the company.
2. Hold General meeting for the approval of shareholders: After giving the 21 days of notice or shorter notice as the case may be, hold the extra-ordinary general meeting and the members approving the same after discussing the amount per share, considering the auditor’s valuation report and other aspects.
3. Filling of forms with Roc: The authorized representative appointed in the board meeting held responsible for informing to ROC by filling the Form MGT-14 in the period of 30 days annexed with the following attachment like notice of Extra-ordinary general meeting annexed with the explanatory statement, copy of resolution of general meeting, minutes of the meetings, offer letter, updated loan agreement, consent of creditors on the conversion process and any other as required.
4. Updating in Loan Agreement: The Company shall circulate the updated loan agreement to the creditors with the offer letters stating the number of shares at the specified rate in the conversion of their loan amount into equity.
5. Conduct Board meeting for allotment confirmation: There is need of passing a second board resolution in the another board meeting considering the allotment procedure to the eligible shareholders with the intimation to the depositories, merchant bankers and other intermediaries involved after the concept of dematerialization introduced this year for the private companies also covered in the eligible criteria specified by the Ministry of Corporate Affairs.
6. Filling Form PAS-3 after allotment: After passing of board resolution for allotment of shares, e-form PAS-3 needs to be filed with the Registrar within 30 days of passing of the resolution. Also the authorized person shall responsible for the other requirements and obligations after the allotment of shares like circulating the share certificates at their registered mail id and updating the register of members and other documents as required.

QUICK SUMMARY

Conversion of loan into equity under Companies Act, 2013 is a strategic mechanism that allows companies to restructure debt into share capital, enhancing financial stability without immediate cash outflow. As per Section 62(3), a company can convert a loan into equity shares if the terms are agreed upon at the time of loan issuance and approved by shareholders through a special resolution. The process involves drafting a loan agreement with a clear conversion clause, obtaining necessary approvals, conducting valuation if required, and filing prescribed forms like PAS-3 and MGT-14 with the Registrar of Companies. This approach is commonly used in startup financing and promoter funding.

CONCLUSION

Loan-to-equity conversion is a strategic win-win for both companies and investors. While companies gain breathing room on cash flow, investors get a chance to participate in the company’s future success.