On 10 January 2017, the Reserve Bank of India (RBI) notified the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) (Fifteenth Amendment) Regulations 2016 (Amendment), amending the Foreign Exchange Management (Transfer or issue of Security by a Person Resident outside India) Regulations 2000 (Regulations).


A classic convertible note (Note) - one of the most preferred instruments for early stage funding of startups in Silicon Valley and toerh 'advanced startup ecosystems' - represents a debt which converts into equity only upon the occurrence of a contingent event (for instance, the issuing startup receiving the next round of funding). If such an event does not take place, the Note continues to represent the debt, which is repayable by the issuing startup. Under the Regulations, until now, foreign direct investment (FDI) in Indian startup companies could only be made by persons resident outside India (Foreign Investors) by subscribing to equity instruments and other instruments that were considered on par with equity instruments (such as mandatorily and fully convertible debentures / preference shares and warrants) of such investee companies.

Key changes

The Amendment permits Indian startups to raise funds from Foreign Investors by issuing Notes, with the following key features:

  • Definition: A ‘Note’ has been defined as an instrument issued by a startup evidencing receipt of money initially as debt, which is either: (a) repayable at the option of the holder; or (b) convertible into equity shares (within a period of 5 years from the date of issue) upon occurrence of specified events according to the terms of the Note.
  • Minimum purchase amount: Foreign Investors are required to invest at least INR 25,00,000 or more in a single tranche to subscribe to the Notes, and issuance of equity shares against such Notes needs to comply with the Regulations. In addition, non-resident Indians are permitted to acquire Notes on non-repatriation basis in accordance with the Regulations.
  • Escrow for remittance of consideration: In addition to the usual permitted modes of remittance, escrow arrangements have also been permitted for making remittance of consideration for subscription to Notes. Such escrow account needs to be closed upon the earlier of: (a) the allotment of the Note and the remittance of consideration to the issuing startup; and (b) the expiry of 6 months from the account opening date.
  • Transferability: Investors are also permitted to acquire / transfer the Notes by way of sale, so long as the sale takes place in accordance with the pricing guidelines prescribed by the RBI.
  • Government approval: Where startups are engaged in sectors requiring government approval for foreign investment, government approval needs to be obtained before issue / transfer of the Notes to Foreign Investors.
  • Compliances: Startups issuing Notes are required to furnish reports as prescribed by the RBI.

Khaitan Comments

The Amendment opens up an important avenue of fund raising for Indian startups and is likely to make them more attractive to early stage Foreign Investors who are accustomed to invest by way of Notes. The redemption feature of the Note is also expected to make startups more accountable. In a way, the Amendment permits a certain minimum guaranteed return to Foreign Investors, which the Regulations do not otherwise permit.

Despite the pathbreaking features set out above, the Amendment is expected to have limited impact on the overall foreign investment into India, as it is applicable only to entities defined as ‘startups’ by the Department of Industrial Policy and Promotion (ie, an entity which is not more than 5 years old and the turnover of which has not exceeded INR 25,00,00,000 for any financial year). Also, certain aspects are not entirely clear from the language of the Amendment – for instance, whether the Note, if not converted earlier, becomes compulsorily convertible at the end of the 5 year period, and whether there is any pricing / interest rate restriction on the issuance of the Note. One would be inclined to think that the answer to both these questions is in the negative. However, an official word from the RBI on these and other such questions would surely help. Further, where the issuing startup fails to do well, the Foreign Investors will have no option but to write-off the debt.

Despite the ambiguities in the Amendment, the positive impact of the Amendment on the overall foreign investment sentiment and India’s image as a progressive ecosystem for startups cannot be undermined.