Introduction

The Department of Industrial Policy and Promotion (hereinafter referred to as “DIPP”), under the aegis of the Ministry of Commerce and Industry released the Consolidated Foreign Direct Investment Policy 2017[1] (hereinafter referred to as “FDI 2017”) with effect from August 28, 2017. FDI 2017 supersedes the consolidated FDI Policy 2016 issued by the DIPP on June 7, 2016 and consolidates all the press notes issued by the DIPP from June 7, 2017 to August 27, 2017.

Of the many reforms introduced by FDI 2017 to attract foreign investment and boost economic growth, the most remarkable one is the inclusion of provisions specific to startups in FDI 2017 for the very first time. 

Raising Funds

The FDI 2017 lists start-ups as a separate section and spells out provisions that allow them to raise foreign money from venture capital funds and other investors through instruments such as convertible notes. FDI 2017 has allowed startups to raise 100% funds from SEBI (Securities and Exchange Board of India) registered Foreign Venture Capital Investors (hereinafter referred to as “FVCI”) under the automatic route. The startup companies can issue equity or equity linked instruments or debt instruments to FVCI against receipts of foreign remittance. If a startup is organized as a partnership firm or a Limited Liability Partnership (LLP), the investment can be made in the capital or through any profit-sharing arrangement. FVCIs may also invest under the FDI Scheme, as non-resident entities, in other companies, subject to FDI Policy and the Foreign Exchange Management Act, 1999 (hereinafter referred to as “FEMA”).

Issue of Convertible notes by Startups

FDI 2017 has introduced the issuance of Convertible Notes by startups to persons outside India. Convertible Notes are instruments representing debt repayable at the option of the holder, or convertible into equity shares within 5 years from issue. Clause 2.1.9 of FDI 2017 defines Convertible Notes as “an instrument issued by a startup company evidencing receipt of money initially as debt, which is repayable at the option of the holder, or which is convertible into such number of equity shares of such startup company within a period not exceeding five years from the date of issue of the convertible note, upon occurrence of specified events as per the other terms and conditions agreed to and indicated in the instrument.”

This provision is in pursuance to amendment of Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) (Fifteenth Amendment) Regulations, 2016,[2] dated 10 January 2017.  The aforesaid amendment allows startups to issue convertible notes to foreign investors. The amendment states that A person resident outside India (other than an individual who is citizen of Pakistan or Bangladesh or an entity which is registered / incorporated in Pakistan or Bangladesh), may purchase convertible notes issued by an Indian startup company for an amount of twenty five lakh rupees or more in a single tranche. Earlier, FDI in startups could only be made by foreign venture capital investors by subscribing to equity or equity linked instruments or debt instruments

Conditions for issue of Convertible Notes 

  1. As per FDI 2017, startups can issue convertible notes to person resident outside India subject to the following conditions:
  2. A person resident outside India (other than an individual who is citizen of Pakistan or Bangladesh or an entity which is registered / incorporated in Pakistan or Bangladesh), may purchase convertible notes issued by an Indian startup company for an amount of twenty five lakh rupees or more in a single tranche.
  3. A startup company engaged in a sector where foreign investment requires Government approval may issue convertible notes to a non-resident only with approval of the Government
  4. A startup company issuing convertible notes to a person resident outside India shall receive the amount of consideration by inward remittance through banking channels or by debit to the Escrow account maintained by the person concerned in accordance with the Foreign Exchange Management (Deposit) Regulations, 2016, as amended from time to time.
  5. Non-Residents may acquire or transfer Convertible Notes from or to persons resident India or Non-Residents only in accordance with applicable pricing guidelines under FEMA
  6. Start-ups issuing Convertible Notes must comply with reporting requirements prescribed by the Reserve Bank of India