{"id":245494,"date":"2021-03-13T16:30:29","date_gmt":"2021-03-13T11:00:29","guid":{"rendered":"https:\/\/www.scconline.com\/blog\/?p=245494"},"modified":"2021-03-13T15:48:40","modified_gmt":"2021-03-13T10:18:40","slug":"convertible-notes","status":"publish","type":"post","link":"https:\/\/www.scconline.com\/blog\/post\/2021\/03\/13\/convertible-notes\/","title":{"rendered":"Issue of Convertible Notes by Indian Start-up Company"},"content":{"rendered":"

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Start-up ecosystem is always dynamic and volatile. They are always in search of innovative funding and that too in a cost-effective manner. In order to promote start-ups, the Government comes out with innovative initiatives, either they give exemption from regulatory requirements or provide cost-effective funding. One of the steps taken by the Government was the introduction of convertible notes under the Companies Act, 2013, specifically for start-ups. The Ministry of Corporate Affairs vide Notification[1]<\/a> dated 29-6-2016, amended the Companies (Acceptance of Deposits) Rules, 2014[2]<\/a>, which provides that \u201can amount of twenty-five lakh rupees or more received by a start-up company, by way of a convertible note (convertible into equity shares or repayable within a period not exceeding five years from the date of issue) in a single tranche, from a person\u201d is considered as exempted deposits. Further, Reserve Bank of India also amended the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2016, to introduce the concept of convertible notes under FEMA.<\/p>\n

Herein, I have prepared a detailed note on convertible notes which can be issued by start-up company to person resident outside India. But, before going into the nitty-gritty of the topic, let us see the current scenario of foreign funding coming into India. Herein is provided the total amount of foreign funding coming into India during January to March 2020[3]<\/a>:<\/p>\n

    \n
  1. Total FDI inflows into India (Equity inflows + Reinvested earnings + Other capital) : USD 18,325 million.<\/li>\n<\/ol>\n
      \n
    1. FDI equity inflows into India: INR 95,549 crores<\/li>\n
    2. Top three investing countries (FDI equity inflows) in Financial Year 2019-2020: Singapore: INR 103,615 crores, Mauritius: INR 57,785 crores and Netherlands: INR 46,071 crores.<\/li>\n
    3. Top three sectors attracting highest FDI equity inflows in Financial Year 2019-2020: Services sector: INR 55,429 crores, Computer software and hardware: INR 54,250 crores and Telecommunications: INR 30,940.<\/li>\n
    4. Top three States attracting highest FDI equity inflows in Financial 2019-2020: Maharashtra: INR 52,073 crores, Karnataka: INR 30,746 crores and Delhi: INR 28,487.<\/li>\n<\/ol>\n

      We have seen the total amount of foreign investors have invested in Reliance Jio i.e. INR 1,04,326.65 crores.<\/p>\n

      Application of Law<\/strong><\/span><\/h3>\n

      For issuing convertible notes, the following FEMA laws shall be applicable in addition to other laws:<\/p>\n

      a. Foreign Exchange Management Act, 1999[4]<\/a> (hereinafter referred to as \u201cFEMA\u201d).<\/p>\n

      b. Foreign Exchange Management (Non-debt Instruments) Rules, 2019[5]<\/a> (hereinafter referred to as \u201cthe NDI Rules\u201d).<\/p>\n

      c. Foreign Exchange Management (Mode of Payment and Reporting of Non-Debt Instruments), Regulations, 2019[6]<\/a> (hereinafter referred to as \u201cMode of Payment and Reporting Regulations\u201d).<\/p>\n

      Regulatory Provisions<\/strong><\/span><\/h3>\n
        \n
      1. What are convertible notes?<\/em><\/li>\n<\/ol>\n

        Convertible note means an instrument issued by a start-up company acknowledging receipt of money initially as debt, repayable at the option of the holder, or which is convertible into such number of equity shares of that company, within a period not exceeding five years from the date of issue of the convertible note, upon occurrence of specified events as per other terms and conditions agreed and indicated in the instrument.<\/p>\n

          \n
        1. Who can issue convertible notes?<\/em><\/li>\n<\/ol>\n

          A convertible note can be issued by an Indian start-up company.<\/p>\n

            \n
          1. What is the meaning of start-up company?<\/em><\/li>\n<\/ol>\n

            Start-up has been defined by the Department of Industrial Policy and Promotion (hereinafter referred to as \u201cDIPP\u201d), Ministry of Commerce and Industry vide amended Notification dated 16-1-2019.<\/p>\n

            An entity shall be considered as a start-up:<\/p>\n