As per Rule 2 sub-rule (e)of the Foreign Exchange Management (Non-debt Instruments) Rules, 2019 issued and amended from time to time, Convertible Note means:- an instrument issued by a Startup 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 ten years from the date of issue of the convertible note, upon occurrence of specified events as per the other terms and conditions agreed and indicated in the instrument;
As per the Rule 2(ixa) of The Companies (Acceptance of Deposits) Rules, 2014, Convertible Note means: an instrument evidencing receipt of money initially as a debt, which is repayable at the option of the holder, or which is convertible into such number of equity shares of the Start-Up upon occurrence of specified events and as per terms and conditions agreed to and indicated in the instrument.
As per Rule 2(ixa) of Companies (Acceptance of Deposits) Rules, 2014: “An amount of twenty five lakh rupees or more can be received by a Start-Up company, by way of a convertible note (convertible into equity shares or repayable within a period not exceeding ten years from the date of issue) in a single tranche, from a person.
1. Pre-requisites for issuing Convertible Notes: For the CN option to be used and amounts to be raised the following conditions need to be met:
1) The Company must be recognized as “Start-up” by the Department for Promotion of Industry and Internal Trade (DPIIT).
2) The amount to be raised should be twenty-five lakh rupees or more in a single tranche from a person i.e. the minimum amount to be invested in one tranche by one investor is Rs 25 lakh.
3) The CN may be redeemed or converted into equity shares of the issuer Start-up within a period of not exceeding ten years.
4) The Convertible Notes shall be convertible into equity shares of the Start-up company upon occurrence of specified events and as per the other terms and conditions agreed to and indicated in the instrument.
2. CN: characteristics and advantages
1) A CN can be issued only by a Startup Company.
2) A CN creates flexibility for the holder: it can be converted and redeemed at the option of the CN holder or as per agreed terms.
3) The tenure is a maximum of ten years and the interest rate can be set as per agreement between issuer and holder subject to a ceiling based on a market-related rate.
4) The transfer of the CN to non-resident is under the automatic route- no RBI permission is required.
5) The CN’s require an amount of INR 25 lakh or more to be invested by a person in a single tranche.
6) In case of transfer of the CN, a valuation report is required from a Chartered Accountant who is a registered valuer with the Insolvency and Bankruptcy Board of India (IBBI).
7) There is no end use restriction on the funds received.
8) There is no minimum interest rate required.
9) It includes the option to convert to equity or to redeem the CN
10) It has sufficient tenure: There is a 10 year period to execute the redemption or conversion processes.
3. Procedure:
1) Company can issue Convertible Note under the provision of Section 62(3) of the Act (i.e., raising money as convertible debt) by passing Special Resolution and accordingly file form MGT-14 with ROC within a period of 30 days.
a) Identify Investor(entity/individual)
b) Finalize the Terms of Convertible Note agreement and procure Valuation Report
c) Convene a Board Meeting for approval of below:
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- Execution of Convertible Note agreement
- Issuance of Convertible Note
- Check your articles, if alteration required
- Notice of General Meeting
d) Convene a Shareholder Meeting for approval of below: Issuance of Convertible Note Alteration of Articles, if required
e) File E form MGT14 within 30 days of passing the shareholders resolution
f) Issuance of Convertible Note Instrument.
There are no specific timelines as per Act. However, the Company can issue the Note as per the agreed Terms and Conditions in the Convertible Note Agreement
On completion of 10 years or upon occurrence of specified events as per the terms and conditions agreed to and indicated in the instrument or Convertible Note agreement, whichever is earlier, Company may convert the note into equity shares at the agreed conversion price by following the specified procedure under Companies Act, 2013.
The price at the time of conversion should not, in any case, be lower than the fair value worked out, at the time of issuance of such instruments, in accordance with the FEMA regulations.
4. Reporting Requirements
a. The Indian startup company issuing Convertible Notes to a person resident outside India shall file Form CN within 30 days of such issue.
b. A person resident in India, who may be a transferor or transferee of Convertible Notes issued by an Indian startup company shall report such transfers to or from a person resident outside India, within 30 days of such transfer.
c. An Indian company which has received FDI shall submit Form FLA to Reserve Bank on or before 15th day of July of each year.
d. The price/ conversion formula of the instrument is required to be determined upfront at the time of issue of the instrument.
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