Lawsikho Blog

Learn how to convert preference shares into equity shares in accordance with the Companies Act 2013 and its corresponding rules. This guide breaks down the law, shares real-life examples and practical insights from deal experience. The article is perfect for lawyers and law students navigating corporate transactions.

Introduction

Imagine you are Priya, a new lawyer in your first week at a prestigious law firm. 

Your senior walks up to your desk and says, “Priya, our client needs to convert preference shares into equity shares by next week. Can you handle it?”

You nod confidently, but as soon as your senior walks away, panic sets in.

“Convert preference shares into equity? What does that even mean? What are preference shares again? And how do you convert them?“

Whether you are a junior lawyer, a law student, or even a seasoned professional facing this task for the first time, do not worry; we have all been there.

In law school, we learn about shares in abstract terms. But in actual practice, when a client or senior asks you to handle a share conversion, there is no textbook to flip through. You need to know exactly what to do, step by step.

That is why I am writing this guide. 

In this guide, I will walk you through everything you need to know about converting preference shares into equity shares, starting from the absolute basics.

After significant years as a corporate lawyer, handling countless conversions, I have realised there is surprisingly little practical guidance available.

So, let us begin as if this is your first day, too.

Understanding shares: The absolute basics

Before we get into the conversion process, let us make sure we are all on the same page. Let us start with the basics.

What exactly is a share swap?

To put it in simple words, a share swap (or conversion) means trading one type of share for another.

Imagine you have a special toy that guarantees you get one candy every month. Now imagine trading it for a different toy that does not guarantee any candy but gives you a say in how the toy store is run. And if the store does really well, you might get lots more candy in the future. 

That is basically what happens when you swap preference shares for equity shares.

What are the different types of shares?

Before we can understand conversion, we need to know what we are converting. 

Think of a company as a big chocolate cake. When people invest in this cake, they get a slice. But not all slices are created equal. Shares, in general, are like pieces of ownership in a company. If a company is a cake, having shares means you own a slice of that cake. 

What are equity shares?

Equity shares are like regular cake slices:

• you get to vote on how the cake is made and who the bakers are
• you only get extra frosting (dividends) if there is enough to go around after other people get theirs
• if the bakery shuts down, you are the last one to get anything back
• BUT if the bakery becomes super famous, your slice could become worth way more than you paid

In more formal terms, equity shareholders:

• get to vote on important company decisions
• receive dividends only if the company makes a profit and decides to distribute it
• are the last ones to get paid if the company shuts down
• have unlimited upside potential if the company does extremely well

What are preference shares?

On the other hand, Preference shares are like special cake slices with a cherry on top:

• you are guaranteed to get your cherry (fixed dividend) before anyone else gets extra frosting
• you do not usually get to vote on how the cake is made
• if the bakery shuts down, you get your money back before the regular slice owners
• BUT your slice would not grow much in value even if the bakery becomes famous

In corporate terms, preference shareholders:

• get priority in receiving dividends, often at a fixed rate
• have priority in getting their investment back if the company liquidates
• usually do not get voting rights in company decisions
• have limited upside potential, regardless of how successful the company becomes

Who gets these different types of shares?

Now, you might be wondering, if equity shares offer unlimited upside, why would anyone pick preference shares?

Well, it all comes down to risk appetite. 

Not everyone wants the biggest slice of the cake. Some just want a guaranteed bite. Preference shares offer more stability, even if that means giving up some of the excitement that comes with equity.

Let me explain this with an example. 

Imagine a company called Bikaji Pvt Ltd looking to raise money from GreenRock Pvt Ltd (a Mumbai-based VC firm). GreenRock has specifically asked the management of Bikaji for issuance of preference shares with a 10% dividend.

For GreenRock (the investor), this meant:

• they were guaranteed a 10% return every year
• if Bikaji ever closed down, they would get their money back first
• they took less risk than if they had bought equity shares

For Bikaji’s founders, this meant:

• they got the money they needed to grow
• they did not have to give up control of their company
• they did not have to share unlimited profits if business boomed

This is why startups often love issuing preference shares to investors. The founders keep control of decisions, while investors get some safety nets for their money.

In the corporate world, equity shares usually go to:

• founders who start the company
• employees through ESOPs (Employee Stock Ownership Plans)
• investors who believe the company will grow big and want to share in that growth
• anyone who wants a say in how the company is run

Whereas, preference shares usually go to:

• investors who want predictable returns
• people who are more worried about safety than hitting a jackpot
• venture capitalists who want some protection for their money

Why would anyone want to swap?

So why would someone trade their safe preference shares for riskier equity shares? Here are the main reasons:

1. To get a vote: Maybe you started with preference shares because you wanted safety, but now you want a say in how the company runs.
2. For bigger returns: If the company is doing really well, the unlimited growth potential of equity shares might be worth more than the fixed returns from preference shares.
3. Because they have to: Some preference shares are “Compulsorily Convertible Preference Shares” (CCPS), which automatically convert to equity after a certain time or when certain things happen.
4. New investors want it: Sometimes, new investors will only put money in if existing preference shares are converted to equity first.

What happens after the swap?

After converting preference shares to equity, a few important things change:

1. Different rights: The shareholder loses their guaranteed dividend and first-in-line status during liquidation but gains voting rights.
2. Ownership dilution: Existing equity shareholders might own a smaller percentage of the company now that there are more equity shares.
3. Change in control: The balance of voting power might shift, potentially changing who makes decisions.
4. Financial statement changes: The company’s balance sheet will look different because preference shares (sometimes counted as debt) become pure equity.

Imagine our toy example again: You have traded your guaranteed-one-candy toy for a vote-in-the-toy-store toy. You might not get any candy for a while, but if the store thrives, you could end up with a whole bag of candy instead of just one!

Now that you have the basic idea, let us dive a bit deeper into these two types of shares with a simple comparison table:

Feature	Preference shares	Equity shares
Ownership	Shareholders have a preference but not ownership in the traditional sense.	Shareholders have true ownership of the company.
Dividend	Preference in dividends over equity shareholders, often at a fixed rate.	Dividends are paid out of profits, and shareholders only receive dividends if declared by the company.
Voting Rights	Limited or no voting rights.	Full voting rights in decisions like board elections, mergers, etc.
Priority in Liquidation	Preference shareholders are paid before equity shareholders during liquidation.	Equity shareholders are paid last during liquidation, after all creditors and preference shareholders.
Risk	Lower risk than equity shares due to priority in returns, but still carries some risk.	Higher risk due to no guaranteed returns and last priority in liquidation.
Return Potential	Limited return compared to equity shares due to fixed dividend rate.	Higher return potential, as profits and growth are shared among shareholders.

Legal framework governing conversion 

I am sure that by now, you understand the difference between preference and equity shares. Now, let us look straight into the heart of the matter and understand the law that governs the conversion process.

I am saying this from my experience, everyone, from founders to CFOs, tends to assume that a company can convert preference shares into equity shares with just a board resolution. 

But it is not at all that simple.

As lawyers, it is our responsibility to explain the legal framework to our clients. But to do so confidently, we first need to have clarity on what the law is.

One of the biggest challenges I faced when I started to work on securities transactions was locating the correct provisions in the bare act. The provisions of the Companies Act for conversion are not set out neatly in one section. 

They are scattered across the Act and the Share Capital and Debentures Rules, 2014. There are three key provisions you must know of, and they are:

• Section 55 of the Companies Act,
• Rule 9 of the Share Capital and Debentures Rules, and
• Section 48 of the Companies Act.

Before I break these down for you, I would encourage you to take a moment and read through these provisions on your own. 

Do not worry if it feels difficult to grasp. I am going to explain each provision one by one. 

I am assuming that you have given them a quick read. 

Let us move forward.

Understanding section 55 

Pay attention when I say this, section 55 is your starting point. 

This is because it is this section that allows companies to issue preference shares that can be either redeemed or converted to equity. 

But here is the crucial part that you must never forget, ever.

The terms of conversion of preference shares into equity shares must be decided and recorded clearly at the time the preference shares are issued. 

You cannot just say, “I will figure out the details later,” or leave things ambiguous. I will elaborate on the specifics when I discuss Rule 9.

So, what exactly needs to be decided upfront? 

The company must explicitly state whether conversion is even an option when issuing these preference shares. If conversion is allowed at the time of issue of preference shares, then the board resolution must clearly state:

• how many equity shares the preference shareholder will receive
• the conversion price or ratio
• when conversion can happen—whether after a specific time period or triggered by certain events

All of these details must be included in the original board resolution. Miss any of these details, and you are practically inviting trouble, and possibly litigation, down the road.

Let me share a real-life situation with you that I handled. 

I was advising Urban Height Developer Pvt Ltd a few years back. The directors, Mr. Sinha and Mr. Arora, had verbally assured a private investor, Mr. Verma, that his preference shares would be converted after 3 years. 

They made a classic mistake—nothing in writing, no board resolution, no documented terms.

When those 3 years passed and the investor wrote an email asking for the conversion of his preference shares into equity shares, the company got cold feet. Just like that, everyone was facing a potential legal battle in the Delhi High Court.

Since that case, I have been absolutely adamant with all my clients. 

I bluntly tell them to their face that I do not care how friendly your investor is or how much you trust each other—put the conversion formula in the original board resolution. 

It is those few extra paragraphs in your documentation that will save everyone massive headaches later.

Check rule 9 of the share capital and debentures rules, 2014

This is what I do, and you should do it too. Read section 55 and Rule 9 together.

Why am I saying this? It is because just as section 55 gives a company the authority to issue convertible preference shares, Rule 9 tells the company how to do it properly.

At this point, I strongly recommend that you go and take a closer look at sub-rules (2) and (3) of Rule 9. 

These two sub-rules make it absolutely clear that the terms of the issue, including whether the shares are convertible, must be included in two documents:

• The board resolution, and
• The explanatory statement goes to shareholders under section 102.

This is how Rule 9 brings structure to the whole process. 

If your client’s company wants the option to convert preference shares in the future, then the paperwork you would do at the time of issue must follow Rule 9 to the letter. 

You cannot improvise later. There is no discretion here. 

If these details are missing when the shares are first issued, the company may lose the legal ground to convert them later. And you might be the lawyer trying to fix a mess that could have been avoided with one carefully worded resolution.

Check section 48 if you are changing shareholder rights

Now, here is where a lot of lawyers (especially fresh associates) get caught off guard. 

If the conversion of preference shares affects any of the rights attached to those shares, like dividend preference or voting rights. 

Then, the company must comply with Section 48 as well.

This means either getting the written consent of 75% of the preference shareholders or convening a separate class meeting and passing a special resolution.

Step-by-step procedure for conversion 

With over 10 years of practice as a corporate lawyer, I have handled many tricky transactions, especially involving share conversions. To maintain client confidentiality, I will use fictitious names while sharing insights from my past work. 

So, recently, I assisted a promising startup called NovaEdge Technologies in converting their Compulsorily Convertible Preference Shares (CCPS) into equity shares. The NovaEdge was led by the Board of Directors (Mr. Amit Singh and Mr. Piyush Sibal) who were all graduates from the Indian Institute of Technology Delhi (IIT).  

I think it would be best for me to walk you through the conversion process with the help of that transaction. 

Anyways, I am not just going to show you how the process typically works but also the practical complications I encountered and solved along the way.

The scenario: NovaEdge Technologies

NovaEdge had raised ₹10 crores from Accel Capital, a venture capital firm based in Mumbai, in 2021 by issuing CCPS. 

Each preference share was convertible into equity either at the end of three years or if NovaEdge raised a significant Series A funding, whichever happened first.

In early 2024, NovaEdge secured ₹60 crores from an international investor as part of a Series A round. 

But there was one crucial condition: all existing preference shares had to be converted into equity shares first.

Here is how I navigated this process:

Step 1: Check the Articles of Association (AoA)

The very first thing I did was I ask Mr. Sibal to provide me a copy of the company’s AoA through email. 

Just so you know, the AoA determines whether conversion from preference shares to equity shares is allowed or not.

When I reviewed NovaEdge’s AoA, I quickly noticed a significant issue. 

The AoA was silent on conversions. There was no mention of the conversion of preference shares into equity.

Because of this, I had to amend the AoA first. 

I immediately advised Mr. Sibal to call a board meeting for: –

• to amend the Articles of Association of the Company to include the conversion of Compulsorily Convertible Preference Shares (CCPS) into Equity Shares. 
• to approve the convening of an Extraordinary General Meeting (EGM) of the members of the Company for seeking their approval for the amendment of Articles of Association.  

Click here to see the documents.

Thereafter, an Extraordinary General Meeting (EGM) of the shareholders was convened. 

In the EGM, shareholders voted and passed a special resolution under section 14 of the Companies Act, 2013, explicitly permitting the conversion. Click here to see the notice of EGM along with the explanatory statement and special resolutions.

After shareholders passed the resolution, we promptly filed Form MGT-14 with the Registrar of Companies (ROC) within 30-day time period. 

This step delayed the process by around three weeks, but it was necessary to ensure compliance.

Step 2: Review the terms of issue

After sorting out the AoA issue, I examined the original documents which were prepared when the CCPS were issued i,.e.: –

• the Share Subscription Agreement (SSA) and 
• the relevant Board resolutions.

I was happy to see that these documents clearly stated:

“Each CCPS shall convert into 10 equity shares of ₹10 each upon completion of 3 years or a qualified Series A funding round.” 

It means that each CCPS would convert into 10 equity shares either after the expiry of three years or upon the occurrence of a significant Series A round. 

Given that both these events had now happened, the conversion trigger was clearly established.

Had these terms been unclear or left open-ended, we would have faced further delays because fresh negotiations and possibly additional shareholder approvals would have become necessary.

Step 3: Convene a Board Meeting

I helped the NovaEdge draft a Board Meeting notice and resolutions. 

In that meeting, the directors passed a resolution:

• approving the conversion of 1,00,000 CCPS into 10,00,000 equity shares
• confirming that the company’s authorized share capital was sufficient

One small scare—we almost missed checking the authorized capital. 

But luckily, it had been increased last year. If it had not, we would have had to go back and get shareholder approval to increase it under Section 61.

Do not overlook the authorized capital. It can delay the whole process.

Click here to see the draft documents.

Step 4: Was shareholder approval needed?

In 99% of the cases, shareholder approval is not needed.  

This is because the original SSA had already included the conversion terms, and shareholders had passed a resolution back then. 

So, generally, you do not need to call an EGM or pass a fresh special resolution.

But if, for example, the conversion price had changed or the ratio was being altered, then yes, you would need shareholder approval under Section 62(1)(c) and possibly Section 48 (if preference rights were being varied).

Step 5: Allotment of equity shares

Once the Board approved the conversion, the next step was to formally allot the equity shares.

We issued share certificates to the VC fund within 2 months, signed by two directors, and made sure they were recorded in the Register of Members (MGT-1). 

Step 6: ROC filings

This is where a lot of companies trip up.

Within 30 days of allotment, we filed Form PAS-3 (here is an instruction kit for filing PAS-3) with the Registrar of Companies (RoC). We attached:

• the Board resolution
• the list of allottees
• a brief valuation note (because this was originally a private placement)

Since we did not need a special resolution, Form MGT-14 was not required this time. But I have filed that too, in other cases where fresh shareholder approval was needed.

Key compliance and practical issues 

How about I also share with you the practical issues that you might face while transacting the conversion process?  

On paper, converting preference shares into equity looks fairly straightforward. 

But in practice, the moment you begin execution, a host of compliance and practical complications begin to surface. 

Here are the ones that tend to cause the most trouble:

1. Dilution of ownership

This is often the first spark of resistance. 

When preference shares are converted into equity, existing shareholders, especially majority stakeholders, may find their control diluted. 

I have seen boardroom battles where majority shareholders push back hard, particularly if they fear losing voting power. 

It is not just about numbers on a cap table, it is about influence and control.

2. Valuation disputes

The conversion ratio becomes a battlefield if it is not carefully calculated or transparently explained. 

Market conditions may have changed since the preference shares were issued, and company performance may not be what was once projected. This leads to disputes over what is “fair” value. 

Legal advisors are often pulled in to mediate or rework the terms, especially when one side feels shortchanged.

3. Liquidity and market impact

For listed companies, the conversion increases the total float of equity shares. 

I have seen this affect share prices overnight, sometimes just from the announcement. If investors perceive this as a dilution of value, it may spook the market. 

In some cases, it has triggered sell-offs, affecting not just the company’s value but its broader perception in the market.

4. Preference shareholder resistance

One cannot assume that preference shareholders will willingly convert. 

Many hold on to those shares for the preferential treatment, fixed dividends, priority in liquidation, and so on. Once converted to equity, those rights vanish.  Unless the conversion offers a compelling upside or compensation, expect resistance. 

This can turn into a legal standoff unless you manage the narrative well.

5. Financial implications

The balance sheet tells a different story post-conversion. 

Preference shares, often classified as debt or quasi-equity, now move to pure equity. This impacts the debt-to-equity ratio, which can, in turn, trigger alarms with lenders. 

I have worked on deals where the bank asked for renegotiation of loan covenants due to this very change. These are not just technical shifts, they carry financial consequences.

6. Timing and process delays

This is not a one-step process. 

You will need board approval, shareholder resolutions (often special resolutions), and regulatory filings. Each of these stages opens up room for objections and delays. 

I have seen conversions stall for months simply because one investor group refused to sign off at the EGM.

Final thoughts 

Before concluding, I  would say that converting preference shares to equity is a strategic move that requires a solid understanding and perfect timing to successfully flip preference shares into equity shares.

Throughout my career, I have seen countless conversion processes as a strategic move by investors and companies rather than just a conversion exercise. 

Nevertheless, you should remember that everything starts with the Articles of Association—if conversion is not explicitly permitted, you’ll need to amend them first. Never assume this step away.

The terms of issue are your bible in this process. They must clearly specify the conversion ratio, triggers, and timeline from day one. Ambiguity here is a recipe for litigation, as I witnessed in the Urban Height case.

When executing the conversion, pay meticulous attention to authorized capital limits—I cannot tell you how many times I have seen transactions stalled because someone forgot to check if there was room for the new equity shares.

Filing forms with the ROC is non-negotiable. The 30-day window for PAS-3 submissions closes quickly when you are juggling multiple client matters. Mark these dates in your calendar and treat them as sacrosanct.

In my next article, I will be sharing a comprehensive conversion checklist that has saved my team countless hours and helped us execute these transactions flawlessly. 

It is a practical tool I have refined over years of closing these deals, and I believe it will serve as an invaluable reference for both seasoned practitioners and those new to corporate law.

Until then, remember that in share conversions, as in most legal matters, preparation and precision are your greatest allies.