The document provides an overview of NovoJuris, a top-ranked law firm in India, and its expertise in corporate law, including the concept of convertible notes introduced to enhance startup fundraising. It describes who can issue and invest in convertible notes, their eligibility criteria, advantages and disadvantages, as well as tax implications and reporting requirements under Indian law. The document emphasizes the importance of convertible notes for startups in raising funds while outlining regulatory compliance associated with their issuance.

1. DEMYSTIFYING CONVERTIBLE NOTES

2. ABOUT US
• NovoJuris is an innovative, new-age law firm which leverages the best legal research and
knowledge to provide holistic, and value-adding solutions to its clients. Throughout over
a decade of our presence, we have been championed and empowered by our clientele.
Our inventive and research oriented approach has consistently earned us a place
amongst the top law firms of India.
• Ranked amongst the top 50 law firms in India as per the RSG ranking of 2019.
• Ranked amongst the top 10 in venture capital practice area.
• Over 12 years of experience of having worked with more than 1000 businesses on the
continuum of early, growth, mature companies, including large multi-national
companies.
• Specializing in corporate, M & A, technology, IP, capital markets, fund formation, private
equity/ VC investment, mediation.
• More than 450 private equity and M & A deals.

3. • Corporate Advisory
• Fund Formation
• Private Equity
• Venture Capital
• Accelerators
• Mergers and Acquisitions
• Cross Border Transactions
• Externalization
• Business Structuring
• Bankruptcy & Insolvency
• Compliances
• Intellectual Property
• Employment
• Mediation and settlements
• Real Estate
PRACTICE AREAS

4. CONVERTIBLE NOTES: CONCEPT
• To encourage and boost the highly volatile Start-up culture in India, the Govt. of India issued
Consolidated FDI Policy in 2017. The thrust of the policy was to make India an attractive
investment destination for foreign investors. A key feature of these policy announcements has
been to boost fundraising options for home-grown startups by permitting startups to raise funds
through issuance of Convertible Notes which was earlier not allowed.
• The regulatory norms and practices were upgraded, to bring in alignment with prevalent
economic conditions and market dynamics. One of the key initiative taken was the introduction of
“Convertible Notes” (“CN”) which was first introduced by the Ministry of Corporate Affair vide
amendment to Companies (Acceptance of Deposits) Rules, 2014 (“Deposit Rules”), to exempt
money received by a company through issuance of CN from the definition of deposit.
• Convertible Notes makes it easier for start up companies to raise investment from Hongkong,
Silicon Valley, Singapore etc. as CN instrument are extremely popular in these advanced startup
ecosystems.

5. CONVERTIBLE NOTES: CONCEPT
Definition of Convertible Note:
• A convertible note is defined under the Companies (Acceptance of Deposits) Rules, 2014 as an
instrument evidencing receipt of money initially as a debt, which is repayable at the option of the
holder, or which is convertible into such number of equity shares of the start-up company upon
occurrence of specified events and as per the other terms and conditions agreed to and indicated
in the instrument ("Convertible Note").
• The notification dated 29 June 2016 effectively excluded any amount of 25 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, from the ambit of 'deposit'. However, the Rules define start-up as a private company
incorporated under the provisions of the Companies Act, 1956 or the Companies Act, 2013 (the
"Act") and recognised as a start-up under the notification on start-ups issued by the Department
for Promotion of Industry and Internal Trade ("DPIIT").

6. CONVERTIBLE NOTES: ELIGIBILITY
• The issuing entity has to be a private company incorporated under the Companies Act, 2013 or
Companies Act, 1956 and recognized as such under notification dated 17/02/2016 (“DIPP Notification”)
issued by Department of Industrial Policy and Promotion, Ministry of Commerce and Industry (“DIPP”);
• Convertible Notes may be issue to:
 A person who is resident outside India (other than an individual who is a citizen of Pakistan or
Bangladesh or an entity which is registered/ incorporated in Pakistan or Bangladesh), can purchase
Convertible Notes issued by a recognised start-up company. Also, the investors hailing from such
countries sharing land borders with India can invest only through approval route vide Press Note 3
issued by Ministry of Commerce and Trade.
 a Non-Resident Indian (NRI), an Overseas Citizen of India (OCI), Company, a trust and a partnership
firm incorporated outside India and owned and controlled by NRIs or OCIs. However, the investment
will be deemed to be domestic investment at par with the investment made by residents.
• Prior Government approval for the issuance of a convertible note will be required for cases where the
startup is engaged in any activity that falls under the approval route under the existing regulatory
framework for FDI. Startups engaged in sectors falling in the automatic route for FDI do not require any
prior approval with respect to such issuance.

7. CONVERTIBLE NOTES: ELIGIBILITY
• The amount against which Convertible Notes can be issued should be an amount equal to more
than INR Twenty-five Lakhs (INR 25,00,000) in single tranche;
• The amount either repaid or to be converted within 5 years and in case of conversion, it shall be
converted into equity shares only;
• The terms of conversion will have to be determined upfront at the time of issue of Convertible
Notes. However, conversion price can be determined at the time of conversion and price shall not
be lower than the fair market value prevailing at the time of conversion.
• A start-up company shall receive the consideration towards Convertible Notes by inward
remittance through banking channels or by debit to the NRE/ FCNR (B)/ Escrow account
maintained in accordance with the Foreign Exchange Management (Deposit) Regulations, 2016.
Furthermore, the Repayment or sale proceeds may be remitted outside India or credited to NRE/
FCNR (B) account maintained by the person concerned in accordance with the Foreign Exchange
Management (Deposit) Regulations, 2016.
• The issue of equity shares in lieu of convertible notes must be in compliance with RBI’s pricing
guidelines, that is, valuation must be done through any internationally recognised pricing
methodology at an arm’s-length basis by a qualified chartered accountant or merchant banker.
• Convertible notes are freely transferable and can be acquired/transferred by way of sale, provided
the sale is in accordance with the pricing guidelines prescribed by the RBI.

8. PRICING GUIDELINES-CONVERTIBLE NOTES
Unlike other capital instruments, like Equity Shares or CCPS or CCD, pricing guidelines need not to
be complied with at the time of issuance of a convertible note. Valuation shall be determined on at
the time of: (i) conversion of the convertible note into equity; or (ii) In case of transfer of convertible
notes from a non-resident to a resident or vice versa. Therefore, the price of shares issued upon
conversion or transfer must be at or above fair market value, determined by a certified chartered
accountant in practice or cost accountant in practice or Merchant Banker registered with the
Securities and Exchange Board of India.

9. CONVERTIBLE NOTES: PROS
• No valuation requirement at the time of issuance of Convertible Notes;
• Convertible Note is a preferred instrument over convertible debentures in case of bridge
financing, wherein valuation of the Company and subsequent conversion of the instrument is
deferred until the company can secure its next round of funding.
• Since Convertible Notes are debt instruments with an option to be converted into equity, The
company does not have to part with control or voting power when such convertible notes are
issued.
• Convertible note financing are simpler to document from a regulatory perspective, meaning that
they are less expensive and quicker to execute.

10. CONVERTIBLE NOTES: CONS
• If future financing rounds are not completed, the investors may opt not to convert the notes into
equity and the CN will remain as debt and thus require redemption, potentially pushing still-
fragile companies into bankruptcy.
• Certain clauses of the CN agreement such as Valuation cap and the Conversion Discount can
complicate future equity raises by anchoring the price expectations.
• Another disadvantage is the non-alignment of incentives/returns between seed-round investors
and company management. The latter want the Series A round to be at as high a valuation as
possible, so they dilute their ownership as little as they can. In contrast, seed investors want the
next round to be as low as possible so they get the biggest percentage of the company that they
can for their investment.
• Further, a Convertible Note has to be repaid or converted into equity shares of a start-up
company within 5 years from the date of issuance of the Convertible Note. Since the maturity
period is less, the risk involved becomes greater.
• The threshold to invest minimum INR 25 Lakhs for one tranche also becomes a hurdle for start
ups struggling to seek from angel investors.

11. TAXATION
At the time of issuance of Convertible Notes: Convertible Notes being debt initially, there are no
tax implication at the time of such issuance.
At the time of conversion of Convertible Note: The conversion price of such instruments shall have
to be at fair market value. In case if the conversion price is above the fair market value, then the
difference between the conversion price and fair market value may be taxable in the hands of the
company under section 56 (2) (viib) of the Income Tax Act, 1961. However, this is exempted in case
if the company is registered start-up and has tax exemption approval from Income Tax department
at the time of conversion.
In case if conversion price is lower than fair market value, the difference between the conversion
price and fair market value may be taxable in the hands of holder of convertible note under section
56 (2) (x) of the Income Tax Act, 1961.

12. REPORTING REQUIREMENTS UPON ISSUANCE
Companies Act, 2013
Under Companies Act, 2013 and allied rules and regulations thereunder, the Company raising
investment by way of Convertible Notes need to comply with the below regulatory compliances:
 Approval of the Board of Directors to issue the CN;
Approval of shareholders by way of Special resolution in a general meeting;
 Filing of Form MGT-14 with concerned ROC
Execution of CN agreement incorporating the terms and conditions of such notes;
 Receipt of investment from the proposed investors in a single tranche;
 Taking note of the investment received and issuance convertible note certificates to such
investors

13. REPORTING REQUIREMENTS UPON ISSUANCE
RBI
The reporting requirements under FDI regulation include:
 filing of Form CN with 30 days from the issue.
 in case of transfer of such CN, Form CN to be filed within 30 days of such transfer.
 Information to be filled in the form include the details of investor, banking channel used, amount
involved etc.
The Authorised Dealer Bank shall submit consolidated statements to the Reserve Bank upon filing
Form CN.
Delays in RBI reporting
The person / entity responsible for filing the reports provided in Regulation 4 above shall be liable
for payment of late submission fee, as may be decided by the Reserve Bank, in consultation with the
Central Government, for any delays in reporting.

14. REPORTING REQUIREMENTS UPON ISSUANCE
Form CN : Single Master Form is available over FIRMS portal to file form CN on account of
Issuance, Transfer, Conversion or Repayment

15. MEET US
• Address: 495, I Floor, Aisshwaraya ICON, Opposite ICICI Bank, CMH
Road, Indiranagar, Bangalore 560 038
• Phone : 080 40924173, 25544365
• Email: relationships@novojuris.com
• Website: www.novojuris.com