The Indian economy started with a miniscule size of just 2.7 lakh back in
1947. Today it wears the crown of the world's fifth largest economy. Estimates
of the Bank of America claim that in no longer than 10 years, India will become
the world's third largest economy, only behind the US and China.
reforms, that introduced liberalization in 1991 have been a watershed moment for
the Indian economy. However, the game of numbers is deceptive sometimes. Despite
being the fifth largest economy, the per capita GDP stands at less than USD
2000, which tags India as a struggling lower middle-income country.
As an economy advances with time, promotes entrepreneurship and startups,
innovative methods of allocating funds, that prove beneficial not just to
the company but also to the investors, start shimmering and gain momentum quite
at a fast pace. One such innovative method of fund allocation is by way of
In India, convertible notes were introduced through
a notification in 2016, that was aimed at amending the Companies (Acceptance of
Deposits) Rules, 2014. In simple terms, a convertible note is an
instrument, which acts as an evidential receipt of a money that an investor
invests in a company, which is repayable as per the wish of the investor and
also consists of an option of converting the money into the shares of the
company, as per the terms and conditions decided upon earlier.
The above-mentioned notification also added that, "an amount of twenty-five lakh
rupees or more received by a start-up company, by way of a convertible note
(convertible into equity shares or repayable within a period not exceeding five
years from the date of issue) in a single tranche, from a person", to be
considered as exempted deposits.
Also, the RBI made amendments in the
Foreign Exchange Management (Transfer or Issue of Security by a Person Resident
Outside India) Regulations, 2016 and introduced convertible notes under FEMA. Convertible
notes can only be held for a maximum period of 5 years from the day of issuance.
After the same is completed, it has to be repaid or converted into shares.
Convertible notes can be issued to people residing outside India, except for
individuals who are citizens of Pakistan or Bangladesh, and the entities which
are registered or incorporated in Pakistan or Bangladesh. NRIs and OCI
cardholders are also eligible to acquire convertible notes, subject to terms and
conditions as specified in the NDI Rules (Non-debt Instruments).
companies, issuing convertible notes to people residing outside India, they must
receive the consideration amount, by way of inward remittance or by debit to the NRE/FCNR account, maintained by the investor as per the FEMA Regulations.
Schedule 4 of the RBI regulations allow an NRI to acquire convertible notes on
a non-repatriation basis.
The finance ministry, by way of a notification made an amendment in Rule 6a of
the NDI Rules, which said that investments coming from countries sharing a land
border with India will compulsorily require government approval for the same.
The question left unanswered was whether entities registered in the
bordering countries would need government approval even for making investments
by way of convertible notes in the Indian market.
Another loophole in the regulation of convertible notes is evident in the fact
that only recognized start-ups are permitted to issue convertible notes, as per
the RBI regulations, which implies that non-recognized start-ups, even if they
are carrying enough growth aspects, would lag behind due to their incapacity to
issue convertible notes. In the regulatory process of convertible notes, which
are issued under section 42 of the Companies Act of 2013, a mandatory provision
which asks for the disclosure of the valuer's details who has performed such
valuation, along with the justification for the price, usually goes unnoticed by
The regulations around Convertible notes still lack the proper execution of the
laws on the ground level. Many of the mandatory provisions of the same are not
complied with, which implies an inefficient awareness regarding the same. As the
concept of convertible notes is gaining momentum in the Indian market, a more
detailed and comprehensive legislation is required for the fair and justified
regulations of the same.
Law Referred To:
- Companies (Acceptance of Deposits) Amendment Rules, 2016
- Companies (Acceptance of Deposits) Rules, 2014
- Foreign Exchange Management Act, 1999
- Foreign Exchange Management (Non-debt Instruments) Rules, 2019
- Foreign Exchange Management (Mode of Payment and Reporting of Non-Debt
Instruments), Regulations, 2019