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In its simplest form, a creditor's existing debt (including principal and accrued interest) is converted into shares in the borrower. New shares are issued to the lender in satisfaction of the debt and the loan is no longer owed.
Debt-to-equity swaps are common transactions in the financial world. They enable a borrower to transform loans into shares of stock or equity. Most commonly, a financial institution such as an insurer or a bank will hold the new shares after the original debt is transformed into equity shares.
Before taking out a loan, approve a special resolution approving the terms of the loan, and file the special resolution in e-Form MGT-14 within 30 days. By making a resolution at the Board Meeting, convert the loan into shares, and file e-form PAS-3 for allotment of shares under the Companies Act, 2013, within 30 days.
If a company has taken any unsecured loan from its directors and wants to convert such unsecured loan into equity at some future period of time, then it has to ensure to enter into debt conversion agreement with such directors at the time of accepting such loan and also to pass a special resolution.
Typically, the loan converts into equity with a conversion discount in valuation that is lower than the price paid by the investors purchasing shares in the financing to compensate the note holder for bearing the risk of investment prior to the financing. A typical discount is often between 10-30%.