External commercial borrowings(ECB) imply borrowing (debt) from a foreign (non-resident) lender. ECB is an attractive financing route as it generally offers access to finance with low rate of interest available from overseas low interest markets.
ECBs have been in use by many corporations, PSUS and especially by MNCs setting up operations in India. Who can raise an ECB, from where and under what conditions, rate, maturity period etc. are all governed by Reserve Bank of India (RBI) in India. Startups till now did not have access to the ECB route of funding.
RBI announcement on ECB for Startups
Announcement was made by the Reserve Bank in the Fourth Bi-monthly Monetary Policy Statement for the year 2016-17 released on October 04, 2016, for permitting Startup enterprises to access loans under ECB framework.
Sanjay Khan Nagra, iSPIRT volunteer talks about this announcement in the video embedded. Below.
As such RBI circular is self-explanatory attached here. However, for ready reference, some salient features of the RBI announcement are covered in the text given below.
What are the key announcements?
What is a Startups as per circular?
The above circular covers Startups as defined by the Official Gazette of Government of India dated February 18, 2016 (i.e. Startup Policy of DIPP) given here.
How much can a startup borrow and in what currency?
A startup can borrow up to US$ 3 million or equivalent per financial year either in Indian rupee or any convertible foreign currency or a combination of both. In case of borrowing in INR, the non-resident lender, should mobilise INR through swaps/outright sale undertaken through an AD Category-I bank in India.
What is minimum maturity period?
Minimum average maturity period will be 3 years.
For what end-use can startups use ECB?
Usually there are end-use direction for an ECB. However, for startups under the above said circular of RBI, ECB can be used for any expenditure in connection with the business of the Startup.
What is all-in-cost of ECB?
There are no limits. The RBI circular says, this shall be mutually agreed between the borrower and the lender
In what forms can one receive the lending?
It can be in the form of loans or non-convertible, optionally convertible or partially convertible preference shares and the minimum average maturity period will be 3 years.
Can this be converted in to equity?
Yes, conversion into equity is freely permitted, subject to Regulations applicable for foreign investment in Startups.
Who can lend?
Previously, ECB regime inter alia set out various conditions for Indian companies raising loan from external borrowings including conditions relating to (i) eligible borrowers (ii) eligible lenders (iii) permitted end uses etc.
After this circular, the lender / investor shall be a resident of a country who is either a member of Financial Action Task Force (FATF) or a member of a FATF-Style Regional Bodies; and shall not be from a country identified in the public statement of the FATF. (Please see RBI Circular for detail)
However, overseas branches and subsidiaries of Indian banks and overseas wholly-owned subsidiary or joint venture of an Indian company will not be considered as recognized lenders.
What are security norms?
Foreign lenders or Investors are allowed to request security for any collateral in the nature of movable, immovable, intangible assets (including patents, IP rights etc.) but shall comply with foreign direct investment norms applicable for foreign lenders holding such securities.
Issuance of corporate or personal guarantee is allowed. Guarantee issued by non-resident(s) is allowed only if such parties qualify as lender under paragraph 2(c) above. Exclusion: Issuance of guarantee, standby letter of credit, letter of undertaking or letter of comfort by Indian banks, all India Financial Institutions and NBFCs is not permitted.
For more details you are requested to refer the RBI circular here.
RBI relaxes Foreign Venture Capital Investor (FVCI) norms for Startup investment
One more announcement to the stay-in-India check list has come from RBI with respect to registered under SEBI (FVCI) Regulations, 2000.
RBI has announced amendments to the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2000, notified vide Notification No. FEMA 20/2000-RB dated May 3, 2000, as amended from time to time (Principal Regulations).
Sanjay Khan Nagra, iSPIRT volunteer talks about this announcement in the video embedded. Below. Also the main provisions and text is described in this blog below. Those interested in the original regulation may visit this page here.
As per the amendment notification referred to above, any FVCI which has obtained registration under the Securities and Exchange Board of India (FVCI) Regulations, 2000, will not require any approval from Reserve Bank of India and can invest in:
1. Equity or equity linked instrument or debt instrument issued by an Indian company whose shares are not listed on a recognised stock exchange at the time of issue of the said securities/instruments and engaged in any of the following sectors:
(ii) IT related to hardware and software development
(iv) Seed research and development
(v) Research and development of new chemical entities in pharmaceutical sector
(vi) Dairy industry
(vii) Poultry industry
(viii) Production of bio-fuels
(ix) Hotel-cum-convention centres with seating capacity of more than three thousand
(x) Infrastructure sector (This will include activities included within the scope of the definition of infrastructure under the External Commercial Borrowing guidelines / policies notified under the extant FEMA Regulations as amended from time to time).
2. Equity or equity linked instrument or debt instrument issued by an Indian ‘startup’ irrespective of the sector in which the startup is engaged. A startup will mean an entity (private limited company or a registered partnership firm or a limited liability partnership) incorporated or registered in India not prior to five years, with an annual turnover not exceeding INR 25 Crores in any preceding financial year, working towards innovation, development, deployment or commercialization of new products, processes or services driven by technology or intellectual property and satisfying certain conditions given in the Regulations.
3. Units of a Venture Capital Fund (VCF) or of a Category I Alternative Investment Fund (Cat-I AIF) (registered under the SEBI (AIF) Regulations, 2012) or units of a Scheme or of a fund set up by a VCF or by a Cat-I AIF.
iSPIRT believes these announcements have made Govt. Recognize the importance of opening up investment to promote innovative startups. Right now these announcements are limited to Startups recognized by DIPP. However, we hope in future they may be opened for all startups and an easy investment regime in Indian from foreign funding source.
The payment gateway problem in exporting online from India
It is not easy for Indian Software product companies to export products online and receive payments in India. This is true for both the downloadable Software product or Software as a Service (SaaS).
Experts say there is no legal or policy hurdle from RBI. Yet, there is friction. An Indian payment gateway service provider denies foreign currency cross-border transactions from India to a startups or small company. Only exceptions could be some large companies.
As part of ‘PolicyHacks’ at iSPIRT, we attempted to attend to the issue of recurring billing in a previous blog here. This blog is another continued effort in this direction. It is based on a discussion with experts from payment solution companies. Embedded below is a video discussion with Krish Subramanian, Cofounder of Chargebee and Kiran Jain of Razorpay.
The options available and adopted by most small Software product companies’ today are:
Use a foreign payment gateway like PayPal, 2 Checkout, Skrill etc. Or
Setup a branch office or a subsidiary in a foreign country
Incorporate in a foreign country and sell globally from there including India
The option #1 above of using international payment providers comes with a heavy transaction cost. The services are not of same order as one can avail being in US or Europe.
So, option #2 and #3 becomes much attractive. This leads to exodus of Indian Software product company’s to USA, Singapore or Europe etc. India stands to lose in the game.
Krish mentions that, “the Indian companies are forced to move abroad to seek the frictionless experience in the payment part, where they allow month on month and do seamless upgrades and downgrades”. He further adds up, “Indian companies being in India do not get the level playing field, even when the strengths of product are very similar to a foreign product. Even using a solution like 2Checkout being in India does not provide seamless upgrade and downgrade. Hence, many companies go and incorporate outside”.
This problem, therefore, is one of the ‘biggest hurdle’ to the ‘stay-in-India’ concept for startups. It is vital that policy makers pay attention and remove friction to this problem for startups to believe in ‘India Story’.
Kiran Jain of Razorpay mentioned that the added attraction for Indian Software product company to move abroad is that, “an Indian company selling on international payment gateway from outside India does not have to comply with service tax”.
This is another level playing field problem. Being in India the Software product sales online is subject to service tax. On other hand being a foreign incorporated company and selling a B2C product the service tax is totally exempted. This is so in current policy framework and is going to stay same in the proposed GST framework.
Although, this is not directly related to the payment gateway problem, it does add-up to the exodus of Startups problem. This issue has been covered in an earlier blog here. It is a policy agenda item on list of taxation issues (of iSPIRT) to be addressed by Government of India and also an item on Stay-in-India checklist.
The cross-border online trade of Software product is directly a Payment Gateway issue. Let us further understand what are the underlying causes, policy issues, possible resolutions and suggestions.
Is there a regulatory hurdle? If not, then what is the cause of problem?
Kiran says, “RBI came up with OPGSP guidelines in 2014”. And, “this policy allows the operation of International payment gateways”, that can facilitate both the foreign currency cross-border transactions and recurring billing. According to Kiran, many Indian banks have capability to provide platform which can accept international cards and multi-currency systems. Few banks support up to 17 different foreign currencies, though the settlement is all done in US dollars.
Why are banks not giving it? Kiran said that in last one year in USA, out of $28.33 trillion online transactions, $16.33 billion were classified as frauds. Indian banking system does not have a capability to incur such losses, “that is the threat to Indian banks”. This threat is the result of ‘returns’ or ‘charge-back’.
In case of delivery of downloadable Software product, at least there is a trail of transaction that can establish that the Software was really downloaded and if unsuccessful the Software can be delivered again. However, in case of services it may be difficult to handle the consumption trail at least in B2C transactions. In B2B transactions, such problems normally do not arise.
Hence, handling the risk of returns and charge-backs is the problem to solved. Solving this will encourage India banking systems to offer free and fair cross-border international payment gateway services.
What is the solution to problem?
Large players by virtue of volume or by offering a risk covering instruments can easily avail the service from banks themselves.
Small and Medium players can use payment aggregators. PayPal and 2Checkout are nothing but aggregators. Thy have infrastructure built in USA. In India they provide services under OPGSP guidelines. Their relationships with issuing banks in USA enables them to provide services in India.
Kiran says, “as on date we have many aggregators in India”. But, “we have not seen any Indian aggregator moving to US and partnering with banks like Wells Fargo or Worldpay”, who could build “an infrastructure trail in US and bring it to India and start providing cross-border payments”.
This will be a powerful option according to Kiran. This option can be used to ease out cross-border multi-currency payment system aggregation. This will give exporters alternative to PayPal and 2Checkout etc.. This will also reduce transaction costs by at least 30%. Now, an Indian merchant pays 4 to 6% plus the currency conversion costs as a compared to the 2.9% + 30 cents per transaction in USA.
The other advantage of Indian aggregator with US infrastructure will be the better understanding of the Indian merchants and the risks involved. Hence, better placed to manage the risks. “Today PayPal looks at every merchant as risky merchant”, says Kiran. The Indian players can have option of either aggregating the merchants on PayPal model. Or offer facility directly to mid and large players. In later case the entire risk engine is managed by the aggregator. The risk engine will take care of detecting the fraud cards, stolen cards, charge-backs cards as these will not be the capability of a merchant.
In the aggregator model, it is possible to play on volumes by on boarding a large number of small and mid-size merchants. This way an aggregator can easily go to a bank and say my charge-back to sales ratio is just about 1.76%.
Kiran further adds that as an alternative risk mitigation mechanism an Industry body could register small and mid-size Software product companies (merchants) and provide some kind of a certified credit rating. This could help banks and aggregators to assess the risk associated with the individual merchant.
Krish feels, a Govt. body like MSME could build a registration system of merchants with past history, people involved etc. (this could be like extending the Performance and Credit rating scheme of MSME). “This could act as a KYC”, says Krish for the aggregator, payment gateways and banks.
Are there Indian Aggregators offering such services?
As mentioned above, banks offer services in a limited way to large merchants. Aggregators like RazorPay also provide services but again with conditions attached.
Kiran says,“Razorpay provides the services on selective basis. We do not offer the option of card details to be held by merchants”. He further informed that merchant account with many charge-backs are suspended and that cases with one-off charge types may be allowed.
So, there is conditional availability of Indian service providers of cross-border online payment gateways.
Concluding remarks and iSPIRT views
“It is a crying shame if many startups still incorporate outside India just to get a level playing field”, says Krish Subramanian. He also listed following observations:
there is an option that is emerging (in terms of aggregators);
there are no regulatory hurdles per say;
it is more about risk mitigation;
the risk mitigation is about creating awareness by closely working with banks;
it is also about creating awareness amongst merchants themselves to be able to understand reasons why banks act in certain way and about clarity on pricing, return and refund policy etc.
creating overall awareness in eco-system
iSPIRT views on the overall situation on the given problem and present policy status are as follows:
For India to be a Software product nation, Indian resident companies should be able to carry out cross-border trade and receive foreign currency payments onlineseamlessly without opting for incorporating a subsidiary outside India
For a healthy Software product ecosystem, it is vital that Software product companies have access to several options of payment gateway service providers with differing service offerings
RBI alone cannot solve this problem.RBI policy of OPGSP allows the payment gateway players to provide services in India. The inherent risk does not encourage service providers to offer cross-border payment services. RBI may have to become more reformative in encouraging Indian international payment gateway providers.
Government of India needs to intervene and devise an integrative policy that:
promotes an ecosystem of Indian cross-border payment providers
build a mechanism that helps banks and OPGSPs to mitigate their risk without hurting consumer interest
support Software product companies in their cross-border trade by a proactive policy
MeitY can incorporate enabling policy measures in National Software product policy and offer an Indian Software product company registry that has an inbuilt mechanism to ascertain and certify a Software product company’s credibility. Also financial instrument like an Industry corpus fund could provide a common bank guarantee, that can be backup with surety bonds from individual product companies for a defined threshold.
In a digital world order, cross-border trade is going to be highly dependent on easy availability of international payment solutions. Indian merchants able to scale their international trade with ease is vital for India to be retain leadership in Software trade.
Recurring Billing – demystified for SaaS companies
For any SaaS Startup with India market focus, the biggest bottleneck today is recurring billing. It is not available as an open, over the counter service from payment gateways. Most startups have to work around to solve this problem. The workaround may be using an expensive international payment gateway or it may be incorporating a subsidiary in foreign geography. Many startups also move all out of India, if they can afford to do so. In the process India loses some good SaaS companies.
Reading into details, recurring billing is not banned by RBI in India. But, banks and payments gateways do not have the offering available over the counter. Complying with two factor authentication (2FA) and the associated risk of chargebacks are the reasons behind. The payment industry experts say, banks offer it but needs to cover their risk for chargeback scenarios. So, one has to negotiate with banks and therefore large players are able to avail these services.
To bridge the gap startups like Razorpay are building the aggregator payment platform that that can work between the SaaS startups and the Banks to offer recurring billing.
Since, it is not smooth enough, recurring billing is an area, which requires policy maker’s attention. To realize the full potential of a single unified market under GST, the ‘Digital India’ requires a more open, clearly defined and an enabling policy and procedure on digital payments, at par with developed countries.
This article is based on a deep dive into the problem of recurring billing, with experts from payment solution companies Krish Subramanian, Co-founder, Chargebee (Subscription Billing & Recurring Payments Software) and Kiran Jain of Razorpay (a payment gateway aggregator).
Embedded below is a hangout video with these two experts. You may like to watch the video and/or read the blog piece below (which is built on the conversation in the video).
Some terms used in online payment industry
It is a subscription driven model of charging or collecting payment from customer. Both the frequency interval of charging and amount charged are fixed to qualify for recurring billing. Software as a Service (SaaS) companies are the biggest users of this service.
Merchant: A person or business who want to sell goods or services.
Acquiring Bank: It is the Merchant’s Bank
Card holder: The buyer who owns and uses a credit/debit/prepaid card etc. to buy goods and services
Issuing Bank: Itis the Cardholder’s Bank. An issuing bank issues credit cards to consumers.
SaaS industry and status of recurring billing?
SaaS startups offer products or productized services in a subscription model that runs in a per user/seat at a fixed frequency say per month. In SaaS industry, the recurring billing is often at a low cost transactions e.g. $10 to $50 per user per month.
In developed countries like USA online payment gateways and payment aggregator offer these services. A startup in India can sign for the service from these international payment gateways (like 2Checkout and PayPal) sitting in India. This can be done with minimum paperwork and absolutely no hassles. But, the cost is almost double the cost of payment gateway services in India. The down sides are payments may not be real time. Also, currency conversion cost twice. Once, when the Indian customer pay in foreign exchange and again when the international payment gateway pays to the Indian merchant.
Problem is the Indian payment gateways do not provide the recurring billing option as seamlessly as foreign payment gateways. Hence, the need to go to foreign gateway, when an Indian SaaS company wants to sell to Indian customers.
Krish of Chargebee adds, “for SaaS companies a non-negotiable aspect to provide frictionless experience to customers is the ability to collect payments on month on month basis”. (please see the video)
Statutory position of recurring billing in India
If one reads through the RBI’s circulars on two factor authentication (2FA), there is no mention of recurring billing. The RBI’s communication vide RBI/2011-12/145 DPSS.PD.CO. No.223/02.14.003 / 2011-2012 August 04, 2011 covering card not present (CNP) transactions which includes online transactions as also the IVR transactions states following two conditions:
Based on the feedback from the stakeholders and keeping in view the interest of card holders the following directions are issued:
(i) It is mandatory to put in place additional factor of authentication for all CNP transactions indicated in para 4 of our directions dated December 31, 2010 with effect from May 01, 2012.
(ii) In case of customer complaint regarding issues, if any, arising out of transactions effected without the additional factor of authentication after the stipulated date, the issuer bank shall reimburse the loss to the customer further without demur.
For an avid policy interpreter this means 2FA is the requirement for every transaction. It is not a straight forward clear position.
Kiran Jain of Razorpay, reads in to the sentence of same communication, where it says, “The matter was discussed in a meeting of banks with the Reserve Bank of India on June 22, 2011 wherein it was emphasized by the Reserve Bank that while it was not advocating any specific solution in this regard,”. Kiran says, “From RBI perspective there is no restriction in India”. According to him recurring billing is allowed under RBI guidelines provided in first transaction 2FA is followed and there is no restriction even by banks. (please see the video)
If recurring billing is allowed why is it not available openly?
Banks have a risk in complying with the mandatory charge back, in case when customer files a complaint. The issuing banks are supposed to refund to customer in case complaint from the customer. Normally the risk is never transferred to the acquiring bank.
Kiran in the conversation talks about the lack of understanding on risk involved, by merchants in India. Banks needs to cover their risk through transaction fee. Merchants in India don’t want to pay high transaction fees, that can cover the risk involved in charge backs.
Banks are not willing to underwrite the risk for small players. This is why there are no readymade recurring solutions available in Indian online payments.
How can this risk problem be solved?
Kiran says, “the alternative is to create a partner in between the banks and the ecosystem of SaaS companies, who is willing to underwrite the risks”. Razorpay is one such player, who is attempting to solve this problem.
Why can’t a Startup go to Bank directly? What is the way out?
The problem in recurring billing is not only the payment gateway but also the management of the subscriptions. Baking systems are all legacy systems. They are not able to handle the dynamic situations. For example, if a customer lost the card, the new card information should be updated in time. Such gaps are filled by the layer created by third party Payment Gateway solutions.
Also, this further requires some subscription management systems in an online system. Krish calls this “billing intelligence”. This can either be provided by ready made solutions like Chargebee or can also be built in-house.
Startups can solve this puzzle by availing solutions offered by companies like Razorpay and Chargebee. Razorpay reduces the complexities of recurring billing on banking side. Similarly, Companies like Chargebee reduce the complexity of “billing or invoicing intelligence”.
What more can be done on Policy side?
Krish feels, if we engage with banks and banks can build a system that can underwrite risk for small players and also make Bank realize how service providers can help mitigate risk, there can be a chain built to see a successful recurring billing system in India, easily available to SaaS startups.
Kiran’s view is, from policy perspective not much can be done as RBI does not mandate anything specific. It has do’s and don’t type of framework. His view is charge backs are like non-performing assets (NPAs). So, large merchants in India will still get recurring billing solutions from many payment gateway solutions easily and will also have in-house capability to build billing and invoicing platforms.
Looking further (iSPIRT’s Views)
If one researches hard there is possibility to find payment gateways offering recurring billing solutions in India. However, there are lots of questions asked and it is certainly not available as an across the counter service and definitely not to everyone.
Aggregator service like Razorpay have a chance to fill this gap and they will offer valuable service much needed by Startups. A combination of solution like Raozorpay + Chargebee could solve the problem for many startups.
RBI has not banned the recurring billing. On other hand it has also not put the record straight. Going further, there is a need that RBI and Government of India recognize the importance of recurring billing in a digital economy. Once the need is recognized, a layer of reform in policy framework by RBI should be added. Clear regulation that covers all stakeholders as well as encourages banks to offer recurring billing solutions, is needed. A digitally signed online agreement that is backed up by a 2F authentication in first transaction should be enough to cover the paper formalities required for a fixed amount, fixed tenure (frequency of payment) transactions. The buyer of service can revoke the online service agreement online any time. Customer’s risk is therefore limited up to the time he opts out of the service agreement.
RBI will not take actions that promote an Industry. It is Government of India, who should create an enabling policy for SaaS companies. Ministry of Electronics and IT (MEIT) can carve out a scheme that can mitigate risk of Bank, in turn helping SaaS industry. Such things should happen under the National policy on Software product being considered by MEIT.
The bottom line is that the Indian businesses must have access to multiple choices of service providers for availing recurring billing services at a low cost per transaction with a well laid out fraud protection and complaint redressal mechanism.
Both GOI and RBI needs to work together in direction of removing the bottlenecks. India is unveiling a unified digital market with GST coming in. Without seamless digital payments not only we will fall short in our dream of creating a globally competitive SaaS industry but also a fully buoyant ‘Digital India’.
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.