Summary: Companies can convert loans into equity under certain conditions, as specified in their loan agreements. This conversion can improve the company’s balance sheet and debt-to-equity ratio, leading to a more favorable growth outlook. The process involves obtaining shareholder approval through a special resolution, filing necessary forms with the Registrar of Companies, updating the loan agreement, and conducting board meetings for allotment. While conversion can offer benefits, it also has potential drawbacks, such as dilution of existing equity, reluctance from creditors, and restrictions on share trading. Companies must carefully consider these factors before deciding to convert loans into equity.
The company may opt for the option of conversion of loan into equity as per the loan agreement terms and conditions specified, if the maturity of payment of the loan or conversion necessary to be processed.
There are some advantage for choosing the method of conversion of loan into equity are:
1. No further share capital introduced in the specified process,
2. Improve the company balance sheet and debt to equity ratio that giving a comfort and growth prospectus for the company.
As per considering the provision of section 62(3) of the companies act, 2013 read with the applicable rules (Companies (Share Capital and Debentures) Rules, 2014)and regulation specified, defining the process and other aspects regarding the conversion of loan into equity, the terms of issue of such debentures or loan containing such an option have been approved before the issue of such debentures or the raising of loan by a special resolution passed by the company in general meeting.
Also the company need to confirm the terms and conditions specified for the purpose of conversion of loan into equity and alter the provisions as per the process required.
Procedure of conversion of 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.
The above specified process defined the aspects and obligations covered and also attract some limitations needed to be checked when thinking about the conversion and these covered in the points specified below:
1. The new equity which is issued may be less valuable to the current equity. This is because when a company swaps debt for equity, it is sending a negative signal to the entire market. As a result, the prices plummet even further.
2. Not all investors are interested in debt for equity swaps. Most creditors want to be paid in cash because they want to invest it in their own business.
3. This is because the court does not allow these shares to be sold in the open market immediately. There is a restriction on the timing when these shares can be traded.
4. Lastly, interest payment provides a tax shield to the company since interest is a tax-deductible expense. Therefore debt holders get more even though the company pays less.
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