The Central Government in consultation with the Reserve Bank of India (“RBI”), amended the Companies (Acceptance of Deposits) Rules (“Rules”), 2014 vide a circular released by the Ministry of Corporate Affairs (“MCA”) dated September 7, 2020 (the “Amendment”). The amendment alters the definition of convertible note under the definition of what does not constitute a deposit under the corporate law regime in India.

What is a Convertible Note?

A convertible note (“Note”) is a debt instrument which is used for raising funds by start-up companies. The Note entitles the holder of the Note to get repayment for the amount invested or the right to convert the amount deposited along with the accrued interest on the principal amount of investment into equity shares of the company issuing the Note. Start-up company falls within the ambit of the definition of a private company incorporated under the Companies Act, 2013 or Companies Act, 1956 and recognized as such in accordance with the notification released by the Department for Promotion of Industry and Internal Trade, vide notification dated February 19, 2019. Foreign Exchange Management (Non-debt Instruments) Rules, 2019 defines ‘convertible note’ under rule 2(e) as, “an instrument issued by a start-up 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 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”.

As mentioned above, prior to the Amendment, the duration of the Note was restricted to a maximum maturity period of five (5) years. However, post the amendment, the definition of ‘Deposit’ under rule 2(1)(c)(xvii) of the Rules has been amended to exclude any amount of INR 25,00,000 (Indian Rupees Twenty Five Lakhs) or more received by a start-up company, by way of a convertible note, which is convertible into equity shares of the start-up company or is repayable within a period not exceeding ten (10) years from the date of issue in a single tranche, from a person.

Amendment and its impact

The Amendment allows start-ups to raise funds through the Note for a period of ten (10) years as against five (5) years in the erstwhile Rules. MCA amended the rules related to acceptance of deposits by companies in consonance with the Companies Act, 2013. This move offers flexibility to start-ups for raising funds amid COVID-19 pandemic, which has severely impacted businesses and the economy. Companies can opt for the Note instead of availing a loan from a bank or an NBFC. As the Note is a hybrid instrument and the period it offers after the Amendment is of ten (10) years, which would enable the start-ups to raise funds without paying the monthly interest payable on loans and have a repayment duration of maximum ten (10) years.

Thus, the recent amendment is helpful to start-ups in raising funds through the Note. This would be of assistance for the revival of the start-ups which got affected due to the COVID-19 pandemic and would bring them on track. The time period of ten (10) years creates a safe window for the start-ups to raise funds and not come under the ambit of deposits, prohibited under the Rules.

Disclaimer: This is a general informative update and will not amount to legal advice. The opinions expressed here are general in nature and should not be construed as legal opinion. If you have any specific query on this update, we request you to reach out to our team for the relevant advice.