Convertible Note - Requirements and Process of Issue

What is Convertible Note?

Convertible Note is 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.

Convertible Note can be used as an investment option by Indian startups that are looking for raising funds apart from directors, relatives or shareholder’s of the Company.

Convertible Note is a new instrument for availing credit from a Foreign national or Foreign Entity. The condition and requirements of availing Convertible Note is detailed in FEMA Regulations.

Requirements for issue of Convertible Note (CN):

• Convertible Note can be issued only by a 'Startup Company’' recognised by Department of Industrial Policy and Promotion, Ministry of Commerce and Industry (DIPP)
• Convertible Note is an instrument evidencing receipt of money initially as debt, which is repayable at the option of the holder.
• Minimum amount investment in Convertible Note shall Rs.25 Lakhs or more in a single tranche.
• Convertible Note can either be repaid or can be convertible into such number of equity shares of such startup company
• Repayment or conversion to happen within a period of five years from the date of issue of the convertible note
• The terms and conditions of the Convertible Note to agreed to and indicated in the instrument.
• Required Filings of Form CN to be filed with the Reserve Bank of India (RBI)

What is a Startup Company?

‘Startup company’ means a private company incorporated under the Companies Act, 2013 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, Ministry of Commerce and Industry, Government of India and complies with the conditions laid down by it;

A business will be recognised as a ‘Start-up’ under this scheme only after obtaining a Certificate of Registration from Start-up India Hub.

Reporting to RBI

The Indian startup company issuing Convertible Notes to a person resident outside India shall report such inflows to the Authorised Dealer bank in Form CN within 30 days of such issue.

Conditions and Procedure for Issue of Convertible Note (CN)

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), is permitted to invest in Convertible Note issued by an Indian startup company up to 25 lakh rupees or more in a single tranche.

1. If a startup company is engaged in a sector where investment by a person resident outside India requires approval of Government, can issue Convertible Note only if such approval is granted.
2. A Convertible Note issued by an Indian startup company can be converted into equity shares of the company in accordance with FEMA rules, regulations and guidelines.
3. A person resident outside India can 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 entry routes and pricing guidelines.
4. A Convertible Note can be issued on repatriation and non-repatriation basis both. However an NRI or an OCI may acquire convertible notes on a non-repatriation basis in accordance with the instructions / guidelines of RBI.
5. The payment consideration can be received by a person resident outside India by -

• inward remittance through banking channels
• by debit to the NRE/ FCNR (B)
• by debit to “Escrow account” maintained in accordance FEMA regulations.

Provided the escrow account maintained for this purpose should be closed immediately after the requirements are completed or within a period of six months, whichever is earlier. Such an escrow account shall not be permitted to continue beyond a period of six months.

Convertible Note (CN) Agrement

An agreement is required to be executed between the Company issuing Convertible Notes and the Investor detailing the terms and conditions of Convertible Notes.

Convertible Note (CN) Certificate

A Certificate evidencing the issue of Convertible Notes is also to be issued to the investor by the Company issuing Convertible Notes

Convertible Note - Reporting Requirements

An Indian Startup Company issuing Convertible Note (CN) to a non – resident shall file “FORM CN” within 30 days of issue of Convertible Note to Authorised Dealer bank. However there is no clarity regarding timeline within which Convertible Note is to be issued after the receipt of money neither in Companies Act, 2013 nor in FEMA, 1999.

Following documents are required for reporting -

• FIRC and KYC of the non-resident investor.
• Name and address of the investor and AD bank.
• Copy of MOA / AOA
• Certificate of Incorporation
• Startup Registration Certificate
• Certificate from Practising Company Secretary

A person resident in India, who may be a transferor or transferee of Convertible Note shall report about such transfers to or from a person resident outside India, as the case may be, in Form CN to the Authorised Dealer bank within 30 days of such transfer.

Reporting is required at the time of repayment and conversion into equity shares, however no timeline is provided under FEMA, 1999 within which form is required to be filed.