In this session we take up another announcement by ministry of corporate affairs on convertible notes. This is a step forward to solving the problem of receiving funds as loan from foreign investors as convertible notes.
Sanjay Khan Nagra talks about the issue in the video embedded 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. In India, there are other forms of convertible instruments. Such as CCDS/CCPS (compulsorily convertible debenture or preference share). These are not exactly akin to convertible notes prevalent in valley.
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.
What is the new in the recent announcement?
In existing CCD/CCP instruments, company receiving funds upfront enters into an agreement defining the value or a formula at which these will convert in to equity. This value, at which they will convert cannot be lower than the present fair market value. The CCD or CCP are compulsorily convertible if there is a next round of valuation in a specified period. If there is no valuation in that period, then the money raised remains as a simple loan to be repaid.
The convertible note practice in valley is better placed. There also, a convertible note is also a loan given by investor to company. The difference being, the lender gets an advantage to convert debt to equity at a later date at a discounted rate.
So if a Rs.10 share value at later date is Rs. 50, the lender may get a conversion at Rs. 40. Next valuation round may also happen at lower than present fair market value.
So, this seems more of less like similar, what is the problem then?
The anomaly is that the Indian company can raise funds using convertible notes from Indian lenders only, and not from foreign investors.
RBI does not allow valuation linked convertibles notes. iSPIRT approached RBI with this stay-in-India check list item. RBI felt that there has to be an acceptance in company law for the convertible note concept, as akin to the practice in developed world.
iSPIRT approached ministry of corporate affairs (MCA), and the new announcement is a step forward in this direction. We soon expect RBI to follow suit and permit convertible notes from foreign investors.
Are there any conditions in MCA announcement?
MCA has announced a definition for “convertible notes” under G.S.R. 639(E) by amending the Companies (Acceptance of Deposits) Rules, 2014. You can read the complete circular here.
The limitations are:
a) The provision of Convertible note applies only to Startups
b) The amount has to be 25 lakhs or more
As per circular the definition of convertible note is added as follows:
“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 company upon occurrence of specified events and as per the other terms and conditions agreed to and indicated in the instrument.
iSPIRT will actively pursue this further with RBI.
DIPP and MCA have taken an appreciable step forward, in getting the regulation relaxed for DIPP registered Startups.
However, in order to bring the Indian startup ecosystem at par with developed world, the limitation to DIPP registered Startups should not exist. These measures are to be adopted for all startups/companies across country.