Funding

instruments for

startups

Convertible instruments

These instruments, as the name suggests, are hybrid in nature, with dual characteristics. Initially, they act as debt instruments (earning a fixed interest rate or fixed dividend rate) and at a later stage, they get converted into equity – either compulsorily or at the option of the investor – subject to fulfillment of mutually decided conditions.

Since startups, at least in the initial stages operate in cash-preserving mode, the interest/dividend is usually cumulative and converted into equity rather than regular payout in cash. Investment by non-residents in convertible instruments are governed by FDI regulations under FEMA, irrespective of the legal status of the receiving entity. Examples – CNs, CCDs, CCPS.

Non-convertible
instruments

These instruments are not convertible into equity at all and are purely in the nature of debt. Since these instruments do not provide an option to convert into equity, they are the least preferred source of investment for the investors as no equity stake is promised.

Investment by non-residents in non-convertible instruments are governed by ECB regulations under FEMA. Examples – NCDs/NCPS, OCDs/OCPS, PCDs/PCPS, pure loans.

Convertible notes

Definition

Prerequisites for issuing CNs

Features

Features-01

* Vide notification dated 22 April 2020, the Central Government extended the approval route for making FDI in equity instruments to all countries sharing land border with India. However, in our opinion, since CN does not fall under the definition of equity instruments (which includes CCDs and CCPS); restriction on CN issuance with government approval only applies to Pakistan and Bangladesh citizens/entities.

Advantages

Disadvantages

Taxation aspects

Taxation-01

Compulsorily convertible
debentures/preference shares

Definition

Non-convertible/optionally/partially convertible debentures and preference shares are governed by the ECB guidelines which have been discussed later in this document.

Minimum investment

Features

Taxation-01
Non-In case of foreign investors, following conditions are applicable:

Advantages

Disadvantages

Taxation aspects

Taxation-01