Commerce ministry’s integrated FDI allows startups to issue convertible notes for investments

NEW DELHI: The government’s decision to allow convertible notes as a fundraising option for startups from foreign individuals is expected to provide a major push to investments into early-stage companies, say experts.

The commerce ministry’s recent integrated foreign direct investment (FDI) allows startups to issue convertible notes for investments of Rs 25 lakh or more in a single tranche by individuals residing outside India, not including residents of Pakistan or Bangladesh.

For sectors where FDI is not allowed under the automatic route, startups will have to seek government approval to issue convertible notes. “This is something that the industry has been demanding for a long time and should have happened much before,” said Harish HV, partner, India leadership team, Grant Thornton.

“Convertible notes, which are very popular investing instruments in international markets, had been allowed for Indian investors in startups but not for foreign investors.”

The commerce ministry also indicated that startups can raise up to 100% funds from foreign venture capital investors by issuing equity, equity-linked instruments or debt instruments, which industry experts say will ease raising venture capital funding from foreign entities.

As for allowing convertible notes as an option for raising funds from overseas individuals, these experts expect this to bring clarity and sanity to the sector. This is because it is often difficult for individual investors, especially those who are overseas, to assess a domestic company’s worth when its idea is not yet proven.

With the new policy, startups can raise funds by issuing convertible notes to an overseas investor with the option of converting the investment into equity when the company raises its next round of funding. The investor typically gets equity in the company at a pre-determined discount to the valuation of the company at the time of raising capital.

“Convertibles will protect both the startup and the investor since it doesn’t lock the company and investors in an artificial valuation, which is better decided in the next round when an institutional investor comes in,” said Sarath Naru, managing partner at venture capital fund Ventureast.

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