Tag: #StartupIndia

Convertible Notes

Posted on by Sudhir Singh

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 stand

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.

Investment above Fair Market Value – no more Angel tax for Startups

Posted on by Sudhir Singh

In this session we take up a long pending issue of “Angel Tax”. It has been given partial reprieve recently, under StartupIndia plan. We also discuss how startups can raise money from Angels, without getting trapped in fair market value rule of finance act 2012.

Sanjay Khan speaks on the problem, the latest announcement and the way out for startups to raise equity without DIPP route, in the below given google hangout video.

What is this issue of Angel Tax? And what changes after new announcement?

Startups receive equity infusions from various sources. One of the most lucrative and internationally prevalent source is the Individual investor (Angels).

In India income tax department is skeptical about angel investment. This is because, at times angel investment was misused to channelize black money. Artificial valuations is mostly the doubt in mind of income tax authorities.

As per, Finance Act 2012, capital raised by an unlisted company from any individual against an issue of shares in excess of fair market value would be taxable as ‘income from other sources’ under Sec 56 (2) of the I-T Act. This came to be popularly called as angel tax.

So, if fair market value is say e.g. Rs. 10 per share and a startup receives Rs. 15 investment from an Angel investor. Income tax treats this difference i.e. Rs. 5 per share, as income.

As per the above provisions, the angel investments are subject to assessing officer’s approval. The jurisdictional assessing officers of income tax enjoy the discretionary powers. Instances of misuse of these discretionary powers by assessing officers created problems for startups.

Many startups are not serious about the documentation. Mostly, such startups get into problems due to lack of documentary evidence about their valuations.

Govt. of India recently announced a change under StartupIndia policy of DIPP. A Central Board of Direct Taxes notification, dated June 14, made the required changes to Section 56(2)(viib) of the Income-Tax Act, exempting startups raising funds from angel investors. This is limited to the startups approved by DIPP.

Is it available to all DIPP registered startups?

No, not to all startups approved or recognised by DIPP.

There are three kinds of startups now.

(a) General Startups, that have not applied to DIPP or are not even eligible to apply to DIPP.

(b) those who applied and got recognised by DIPP but did not apply for Income tax exemption.

(c) those who fall under (b) and also got the income tax exemption approval of the inter ministerial board of DIPP.

Only the third (c) category of startups are eligible. These startups need not worry about the assessing officer discretion now. The benefit is available so long as they enjoy the income tax exemption under startup policy.

So, if this is not applicable to all startups, does it mean other startups cannot raise equity from Angel investors at all?

The Finance act 2012 provision does not bar angel investments. Startups not under (c) above can raise the investment from Angels (individual investors). The limitation is that the valuations in such cases will  be subject to examination by assessing officer approval.  They have to extra careful about the valuation at each round of funding.

Such startups should get a professional third party valuation reports. Get a valuation reports for all rounds of valuations with proper documentary proofs. You can face the assessing officers with proper documents without any fear.

The recent hype created in media was mainly arising from down rounds. That is when the new round of investment was done at a lower rate than the previous round. This led to income tax doubting the misuse.

In such challenging valuation situations like down round valuations, the startup can get a professional third party valuation from 2 or 3 sources. This way they can deter the assessing officer’s misuse of discretionary power as well as stand any litigation test, if put through.

In essence, a startup can raise honest angel investment at right fair market value. A professional valuation exercise with all objectivity can help you cover the risk.

iSPIRT’ stand

Startups ecosystems in developed countries enjoy a favourable investment climate that proactively promote and protect the angel’s investments.

Government of India should show give clear signal of favourable investment climate in the country.

Government of India should think of measures that can deter black money getting invested in the Startups, instead of doubting each and every investment. For this Govt. should repeal the the provision introduced by finance bill 2012 should. Discretion to assessing officer is not serving the cause of building investment climate.

India seriously needs a policy that promotes angel investments in general, with responsibility of money invested taken by investors rather than Startups.