Foreign Direct Investment (FDI) is an important source of capital for startups in India. The government has introduced various regulations to facilitate FDI in the startup sector. In this article, we discuss the regulations and reporting requirements for FDI in startup companies in India via an issue of Convertible notes.
What is Convertible Note
Convertible notes are financial instruments issued by startups companies that are a hybrid between debt and equity. They are a type of short-term debt that can be converted into equity (i.e. shares in the company) of that start company within a period not exceeding 10 years from the date of issue of the convertible note or upon the occurrence of a specific event as agreed and indicated in the instrument. Essentially, investors in convertible notes lend money to the startup with the expectation that they will receive shares in the company in the future, usually at a discount to the valuation of the next funding round. Convertible notes are often used by startups as a way to raise capital without having to set an explicit valuation for the company, which can be difficult in the early stages when the company is still developing and its future prospects are uncertain.
Convertible Notes for FDI in Startup Companies
A convertible note is an instrument issued by a startup company that acknowledges the receipt of money as debt, which is convertible into equity shares within a specified period. A person resident outside India (excluding individuals from Pakistan or Bangladesh) can purchase convertible notes issued by an Indian startup company for an amount of Rs.25 lakh rupees or more in a single tranche.
However, if the startup company operates in a sector where FDI requires government approval, it can issue convertible notes to a person resident outside India only with such approval. Furthermore, if the startup company issues equity shares against the convertible notes, it must comply with the entry route, sectoral caps, pricing guidelines, and other conditions for foreign investment.
Non-resident Indians (NRIs) and Overseas Citizens of India (OCIs) can acquire convertible notes on a non-repatriation basis. A person resident outside India can acquire or transfer convertible notes from or to a person resident in or outside India, provided the transfer takes place in accordance with the entry routes and pricing guidelines prescribed for capital instruments.
Procedure for Receipt and Repayment of Convertible Notes
The Reserve Bank of India (RBI) has prescribed the procedure for receipt and repayment of convertible notes issued by an Indian startup company. The startup company must receive the consideration amount through inward remittance via banking channels or by debit to the NRE/FCNR(B)/Escrow account maintained by the concerned person in accordance with the Foreign Exchange Management (Deposit) Regulations, 2016.
The repayment or sale proceeds can be remitted outside India or credited to the NRE/FCNR(B) account maintained by the concerned person in accordance with the Foreign Exchange Management (Deposit) Regulations, 2016.
Reporting Requirements for FDI in Startup Companies
The RBI has specified reporting requirements for FDI in startup companies. The Indian startup company issuing convertible notes to a person resident outside India must file Form CN within 30 days of such issue. A person resident in India, who may be a transferor or transferee of convertible notes issued by an Indian startup company, must report such transfers to or from a person resident outside India, as the case may be, in Form CN within 30 days of such transfer.
All reporting must be made through an Authorized Dealer bank, unless otherwise specifically stated in RBI regulations. In case of delay in submission of reports, late subscription fee is payable as decided by RBI.
Conclusion
FDI is an important source of capital for startups in India. The regulations and reporting requirements for FDI in startup companies have been introduced to facilitate FDI and ensure compliance with foreign investment norms. Startup companies and investors must adhere to these regulations and reporting requirements to avoid any legal issues.
