The issue of shares has always been debatable under Section 62 of the Companies Act, 2013. To make sure that a company runs its functions smoothly, debt is often converted into capital. This Act elucidates that conversion of loan into equity is an easy and practical method to raise capital without immediate investments.
Defining Debt & Equity Shares
Equity is money invested in a company by the owners who are called shareholders. The shareholder receives voting rights and he/she can vote in annual meetings which concern the management of the company for the future.
The shareholder receives a cash flow from the equity he/she owns when and if the company pays dividends. There may be a profit, loss, or no change in the original capital invested when he/she sells the equity.
Equity of a company is calculated by deducting the combined assets it has from the total liabilities of the company. The net worth of a company represents its equity, or what the company owns and what it owes.
Therefore, debt conversion to equity is a common transaction in the financial world. This way, a borrower can convert loans into shares or equity.
The Procedure of Conversion of Loan into Equity Shares
As per Section 62(3) of the Companies Act 2013 resolution, there is a procedure for conversion of loan into preference shares:
- Approve terms of the loan by passing a special resolution before taking of loan & file special resolution in e-Form MGT-14 within 30 days.
- Convert loan into shares by passing a resolution in the Board Meeting & File e-form PAS-3 for allotment of shares under the Companies Act, 2013 within 30 days
- Also, issue share certificate by passing Board Resolution & file e-form MGT-14 within 30 days to start the procedure for issue of shares by the private limited company.
As per the provisions of the Companies Act, 2013 you can't take a loan from shareholders of a private or public company. However, a Director and his relatives are allowed to give a loan.
The procedure for conversion of preference shares into equity shares is nothing but a barter, which constitutes transfer by way of exchange. This has been well laid out in Section 45 of the Companies Act.
Stepwise Process of Loan Conversion to Equity
In case a private company wants to convert to a public company, the Companies Act, 2013 gives it the provision to do so by following the below-mentioned process:
STAGE 1: Steps Before Issue of Debenture or Acceptance of Loan
Ø Holding a Board Meeting:
- To pass a resolution for acceptance of loan/issuing of debenture.
- To pass board resolution for conversion of loan into equity shares of the company.
- Issue a notice for holding a general meeting of shareholders.
Ø Holding an Extraordinary General Meeting:
- A company needs to pass a special resolution for conversion of loan or debentures into equity share capital.
- Filing e-form MGT-14 within 30 days from the date of passing the Special Resolution with ROC.
Ø Enter into an agreement for the conversion of loan into equity:
- A company shall enter into an agreement of terms for Loan or Debenture.
- This agreement should contain the terms of converting loans into the equity share capital of the company.
STAGE 2: Steps at the time of conversion of debenture or loan into share capital
Ø Hold a Board Meeting:
- Pass board resolution for allotment of equity shares.
- Prepare a list of all those who have got an allotment.
- Filing the e-form PAS-3 for allotment of shares within 30 days from the date of passing the Board Resolution.
During conversion of loan into debentures, the Companies Act, 2013 states that no cash exchange occurs in the debt-to-equity swap.
This usually helps a company in increasing cash flow by decreasing liabilities. This move ensures that the company does not face a paucity of financial resources. This procedure is beneficial especially for small and medium-sized companies.
Section 62(3) of the Companies Act, 2013
Section 62 of the Companies Act, 2013 under sub-section 3 reads:
“A further issue of share capital.
(3) Nothing in this section shall apply to the increase of the subscribed capital of a company caused by the exercise of an option as a term attached to the debentures issued or loans raised by the company to convert such debentures or loans into shares in the company:
Provided that the terms of the issue of such debentures or loan containing such an option have been approved before the issue of such debentures or the raising of the loan by a special resolution passed by the company in general meeting.”
The resolution under Section 62(3) of the Companies Act, 2013 states that if a company takes a loan on the term, then there can be a conversion of loan into share capital and such an option has to be approved before raising the loan by a special resolution. In doing so, one can initiate an increase in authorised share capital.
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Section 62 of the Companies Act, 2013 - www.mca.gov.in
e-Form MGT-14 - www.mca.gov.in
e-Form PAS-3 - www.mca.gov.in