Structured Biiz

CONVERTIBLE NOTES (CN)

Convertible Notes (CN) as the word itself represent that it is Convertible Note / Receipt issue for future option attached to it. Convertible Notes are the most simple and flexible option for a Startup Companies to raise funds. It is one way for Private Limited to take unsecured loan from a person other than directors. It is also a bit risky as investor has the right to decide if he wants to convert the notes in equity or wants it to be repaid.

A Convertible Note (CN) is a debt instrument. In short, convertible notes are originally structured as debt investments but have a provision that allows conversion of the principal plus accrued interest into equity investment subsequently.

Convertible Notes usually include a provision in which the notes automatically convert to equity, at a discount or at a set valuation, on the maturity date.

Ministry of Corporate Affairs for the first time introduced and recognised convertible instruments as Companies (Acceptance of Deposit) Rules, 2014 (“Deposit Rules”) to exempt money received by a company through issuance of CN from the definition of Deposit. The norms and practices have been recognised by the Ministry so that relevant instruments can be in alignment and prevalent to current economic conditions.

What are the benefits of issuing Convertible Notes?

What are the laws to be followed before issuance of Convertible Notes?

Companies Act, 2013 & Rules

FEMA Act, 1999 & Rules

Definition of Convertible Notes & Startup Company

Under Rule 2(1)(c)(xvii) of the Companies (Acceptance of Deposit) Rules, 2014, “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.

Under Rule 2(e) the FEMA (Non-debt Instruments) Rules, 2019, Convertible Note‘ means an instrument issued by a Startup Company acknowledging receipt of money initially as debt, repayable at the option of the holder, or which is convertible into such number of equity shares of that Company, within a period not exceeding 5 (five) years from the date of issue of the Convertible Note, upon occurrence of specified events as per other terms and conditions agreed and indicated in the instrument

Under Rule 2(1)(c)(xvii) of Companies (Acceptance of Deposit) Rules, 2014, “Startup Company” means a Private Company incorporated under the Companies Act, 2013 or Companies Act, 1956 and recognised as such in accordance with notification number [G.S.R. 127 (E), dated the 19th February, 2019 issued by the Department for Promotion of Industry and Internal Trade]. As per the said notification, a Private Limited Company as defined in the Companies Act, 2013 shall be considered as a Startup:

  1. Upto a period of 10 years from the date of its incorporation/ registration;
  2. Turnover of such Company for any financial years since incorporation/ registration has not exceeded Rs. 100 Crores.
  3. Such Company is working towards innovation, development or improvement of products or processes or services, or if it is a scalable business model with a high potential of employment generation or wealth creation.

Provided that a Company formed by splitting up or reconstruction of an existing business shall not be considered a ‘Startup’.

What is CN Agreement?

What is CN Certificate?

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

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

To whom Convertible Notes can be issued?

Convertible Notes (CN) can be issued by those Private Limited Companies that are registered under Startup India Scheme issued by DPIIT as a Startup Company. Convertible Notes can be issued to:

  • Resident Indians (including Body Corporates)
  • Non-Resident Indians (NRI)
  • Foreign Investors (except individual who is a resident of Pakistan or Bangladesh)

What are the conditions for issuing Convertible Notes?

The conditions that are required to be fulfilled before issuance of Convertible Notes (CN):

What are the reporting requirements for issuing Convertible Notes (CN)?

Companies Act, 2013 & Rules

FEMA Act, 1999 & Rules