• Sudhir Singh

    RBI allows convertible notes for Startups from foreign sources

    As part of policy hacks, we covered the issue of Convertible notes being recognized by Ministry of Company affairs (MCA) in our earlier blog here.

    For benefit of users to start, the convertible note has been explained below.

    What is a convertible note?

    Convertible notes are debt instruments that converts in to equity, at a later date. The lender initially gives a loan with an understanding that he can convert these in to equity. In most cases, this later date is the date of next valuation of the company. If there is no next round of valuation, the company should return the debt back to lender in a fixed time interval.

    Convertible notes are quite popular in startup ecosystems like Silicon Valley in USA.

    Earlier Ministry of corporate affairs has announced acceptance of the convertible note as a concept for startups through a circular no. G.S.R. 639(E) New Delhi, dated 29th June, 2016.

    The announcement by RBI is a development further to the above given MCA circular.

    How does new RBI provision help startups?

    Foreign investors were allowed, foreign direct investment (FDI) by way of equity and other instruments that were at par with equity e.g. compulsorily convertible preference shares/debentures. Convertibles notes were not allowed till now.

    Reserve Bank of India (RBI) notification of 10 January 2017 has amended the Foreign Exchange (Transfer or Issue of Security by a Person Resident outside India) Regulations, 2000, to allow ‘Startups’ to issue convertible notes to foreign investors.

    This opens new avenues for ‘Startups’ to raise funding.

    iSPIRT volunteer Sanjay Khan Nagra, covers the RBI announcement on Convertible Notes here in the video below.

    The complete circular is given here  on RBI website.

    Other provisions in the new RBI notification explained

    Convertible note has been defined in the notification

    ‘Convertible note’ means an instrument issued by a startup company evidencing receipt of money initially as debt, which is repayable at the option of the holder, or which is convertible into such number of equity shares of such startup company, within a period not exceeding five years from the date of issue of the convertible note, upon occurrence of specified events as per the other terms and conditions agreed to and indicated in the instrument.

    Who can invest and how much?

    A person resident outside India (other than an individual who is citizen of Pakistan or Bangladesh or an entity which is registered / incorporated in Pakistan or Bangladesh), may purchase convertible notes issued by an Indian startup company for an amount of twenty-five lakh rupees or more in a single tranche.

    NRIs may acquire convertible notes on non-repatriation basis in accordance with Schedule 4 of the Principal Regulations.

    What is a Startup?

    For the purpose of this Regulation, a ‘startup company’ means a private company incorporated under the Companies Act, 2013 or Companies Act, 1956 and recognised as such in accordance with notification number G.S.R. 180(E) dated February 17, 2016 issued by the Department of Industrial Policy and Promotion (DIPP) , Ministry of Commerce and Industry.

    Govt. approval required for some sectors?

    A startup company engaged in a sector where foreign investment requires Government approval may issue convertible notes to a non-resident only with approval of the Government.

    Inwards remittance of amount?

    A startup company issuing convertible notes to a person resident outside India shall receive the amount of consideration by inward remittance through banking channels or by debit to the NRE / FCNR (B) / Escrow account maintained by the person concerned in accordance with the Foreign Exchange Management (Deposit) Regulations, 2016, as amended from time to time.

    Provided that an escrow account for the above purpose shall be closed immediately after the requirements are completed or within a period of six months, whichever is earlier. However, in no case continuance of such escrow account shall be permitted beyond a period of six months.

    Convertible notes are transferable

    A person resident outside India may acquire or transfer, by way of sale, convertible notes, from or to, a person resident in or outside India, provided the transfer takes place in accordance with the pricing guidelines as prescribed by RBI. Prior approval from the Government shall be obtained for such transfers in case the startup company is engaged in a sector which requires Government approval.

    Compliance and reporting

    The startup company issuing convertible notes shall be required to furnish reports as prescribed by Reserve Bank.

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    Feb, 01
    2017
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