Convertible Notes in India: New FEMA Relaxations Let Startups Raise Up to ₹50 Crore and Defer Consideration
Convertible notes up to ₹50 crore and deferred consideration get easier under the amended rules.
Key points
- A recognised startup may now issue convertible notes to non-residents up to an aggregate of ₹50 crore in a financial year with a single consolidated filing, instead of a Form CN for every tranche.
- Deferred consideration in a transfer of a startup's shares between a resident and a non-resident may be up to 50 per cent of the price for up to thirty-six months, against 25 per cent and eighteen months for other companies.
- The ₹25 lakh minimum per tranche, the ten-year conversion window and the pricing guidelines at conversion are unchanged.
NEW DELHI — Startups raising money from foreign investors through convertible notes, and founders selling shares to non-residents with part of the price payable later, have been given the two relaxations they have asked for since the instrument was recognised in 2017. Amendments to the Foreign Exchange Management (Non-debt Instruments) Rules, 2019 notified this month allow a startup recognised by the Department for Promotion of Industry and Internal Trade to issue convertible notes to non-residents up to an aggregate of ₹50 crore in a financial year with a single consolidated filing, and allow up to half the consideration in a transfer of a startup's shares to be deferred for three years.
"Founders spend too much time on filings and too little on building," a Bengaluru lawyer who advises early-stage companies told The Counsel.
What a convertible note is
A convertible note is a loan that is designed to become equity. Under Rule 2(e) of the Non-debt Instruments Rules, it is an instrument issued by a startup company that acknowledges receipt of money initially as debt, repayable at the option of the holder or convertible into equity shares within ten years of issue — a period extended from five years in 2022 — on terms agreed when the note is issued. It lets an investor fund a company before anyone is ready to agree a valuation: the price of the shares is fixed at the next priced round, usually at a discount or subject to a cap, rather than at the time of investment.
The instrument exists in Indian law only for startups. Only a company recognised under the DPIIT notification may issue convertible notes to non-residents, and the Companies (Acceptance of Deposits) Rules, 2014 exclude a convertible note from the definition of a deposit only if it is for ₹25 lakh or more in a single tranche and convertible within ten years. A company that loses recognition, or issues a note below the threshold, is accepting a deposit it is not permitted to take.
The rules before the amendment
| Requirement | Position |
|---|---|
| Issuer | DPIIT-recognised startup only |
| Minimum per tranche | ₹25 lakh from a single non-resident investor |
| Conversion | At the option of the holder, within ten years, at a price compliant with the pricing guidelines at the time of conversion |
| Sector | Automatic route unless the sector needs government approval, in which case approval is needed for the note |
| Investor from a land-border country | Government approval under Press Note 3 of 2020 |
| Reporting | Form CN within thirty days of issue or transfer; Form FC-GPR within thirty days of allotment on conversion |
| Deferred consideration on transfer | Up to 25 per cent of the price for up to eighteen months, through escrow or indemnity, under Rule 9(6) |
What changes
- One filing for the year. A startup issuing convertible notes to non-residents up to an aggregate of ₹50 crore in a financial year may report all tranches in a consolidated Form CN filed at the end of each quarter, in place of a filing within thirty days of every issue. Issues above the aggregate revert to tranche-wise reporting.
- Longer, larger deferral. In a transfer of a recognised startup's shares between a resident and a non-resident, up to 50 per cent of the consideration may be deferred for up to thirty-six months, through escrow or an indemnity, provided the total consideration complies with the pricing guidelines. The 25 per cent and eighteen-month limits continue for other companies.
- What does not change. The ₹25 lakh minimum, the ten-year window, the pricing guidelines at conversion, the sectoral caps and conditions, and the Press Note 3 approval requirement for investors from countries sharing a land border with India all remain.
Founders spend too much time on filings and too little on building.
A startup lawyer, to The Counsel
How to use the instrument
- Confirm recognition first. The startup's DPIIT recognition must be current on the date of each issue; a lapsed recognition converts the note into an impermissible deposit.
- Draft the conversion terms now. The discount, the valuation cap, the trigger events and the holder's option to seek repayment must all be in the note; conversion later is at a price that cannot be below fair value under the pricing guidelines, whatever the note says.
- Mind the ten years. A note that is neither converted nor repaid within ten years is a contravention; build the outside date into the investment agreement.
- Route the money correctly. Receipt through banking channels, a foreign inward remittance certificate and know-your-customer documents for the investor are the basis of the Form CN filing.
- Plan the conversion filing. Allotment of shares on conversion is reported in Form FC-GPR within thirty days, with a valuation certificate from a chartered accountant or merchant banker.
- Watch the deposit rules on the Companies Act side. The note must be for ₹25 lakh or more in a single tranche from each investor; splitting a round into smaller notes from several non-residents does not satisfy the threshold per investor.
What the relaxation does not fix
Convertible notes remain unavailable to companies that are not recognised startups, which excludes most companies more than ten years old or with turnover above ₹100 crore. Resident investors cannot use the instrument at all except under the deposit-rule exemption. And the pricing guidelines at conversion continue to produce the anomaly the industry has complained about: a note that promised a discount to the next round may convert at a higher price than agreed if fair value has risen, because the guidelines set a floor that the parties cannot contract around.
What is a convertible note under Indian law?
An instrument issued by a DPIIT-recognised startup acknowledging receipt of money initially as debt, repayable at the holder's option or convertible into equity within ten years on terms agreed at issue, under Rule 2(e) of the Non-debt Instruments Rules, 2019.
What is the minimum investment by a foreign investor?
₹25 lakh or more in a single tranche, which is also the threshold under the Companies (Acceptance of Deposits) Rules for the note not to be treated as a deposit.
How is the issue reported to the Reserve Bank?
In Form CN on the FIRMS portal through the authorised dealer bank within thirty days of issue or transfer, and in Form FC-GPR within thirty days of allotment on conversion. The amended rules allow consolidated quarterly Form CN filings for recognised startups up to ₹50 crore a year.
Can part of the price for shares be paid later?
Yes. Rule 9(6) allows up to 25 per cent of the consideration to be deferred for up to eighteen months through escrow or indemnity; for recognised startups the amended rules allow up to 50 per cent for up to thirty-six months.
The Counsel will report the Reserve Bank's operational directions as they are issued. Startups structuring a convertible note round should take advice from a qualified FEMA practitioner on recognition, pricing and reporting before the money is received.
Dev Patel
Dev writes on company law, FEMA and the compliance burden on growing businesses.
This report is for general information only and does not constitute legal advice. Readers should consult a qualified lawyer about their own circumstances. Case citations are to The Counsel Reports (TCR) unless otherwise stated.