Convertible Notes: A Simpler Form of Fundraising

91springboardInvesting in India, Startup Advice, Venture Capital1 Comment

Fundraising for startups in India can be a cumbersome and tedious process. From haggling over an accurate valuation for a startup that is still building its product to having to procure a valuation certificate and a string of board and shareholders’ resolutions; the entire process can sometimes leave you needing a break even before your business can start up!

I was often asked why we couldn’t simply do a convertible note instead. The answer is simple: until very recently, Silicon Valley-style convertible notes were not an option in India.

In its simplest form, the Convertible Note is an investment that takes the form of an IOU as in “I (O)we yo(U) money!”, which can be linked to the expected returns from a startup, rather than a valuation or a percentage of ownership. This helps entrepreneurs and investors alike to avoid the valuation quagmire for a seed stage investment.

Until recently, the Convertible Note process in India still required you to allot instruments like “Compulsorily Convertible Preference Shares” (CCPS) or “Compulsorily Convertible Debentures” (CCD), which involved a ton of compliance-related paperwork, and was mostly pointless because it still required you to assign a valuation to the startup, either in the form of a current valuation or as a potential future conversion value.

A Convertible Note is typically set up like a debt instrument, with an interest rate and maturity date, along with a discount on the next significant round of investment that values the startup. If the Convertible Note hasn’t converted by the maturity date, it instead becomes equity in the startup, which would require setting a valuation for this potential conversion today. But, unlike a CCD, the convertible note does not require filing a valuation certificate on the issue date.

In one of many steps being taken to ease business in India, the Government of India’s Ministry of Commerce and Industry has permitted “recognized startups” to raise funding through the convertible note route. Thus, if your company has received a Certificate recognizing you as a part of the government’s Startup India Action Plan,, you can now accept funds in the form of a debt from investors, which can then be converted into equity at a future date.

Of course, everything comes with conditions. In order for a recognized Startup to receive funding through Convertible Notes, it will have to comply with the following additional conditions:

  • The minimum investment in a single tranche will have to be at least INR 25 lakhs (~ US$ 40,000)
  • The amount will have to be converted within 5 years
  • The terms of conversion will have to be determined upfront

Most of the value of a startup is in the idea and vision of the founders and their team. Unlike the lengthy and paperwork-intensive process of selling equity in traditional priced rounds of financing; a company can issue a Convertible Note quickly and efficiently, without having to procure multiple documents or amend the charter documents. As a flexible, one-document security, without numerous terms to negotiate, the Convertible Note should save companies and investors both money and time.

Take this quick 2 minute test to find out if you can raise or invest in Convertible Notes!

For those who haven’t fundraised or just prefer pictures to words, here’s a quick infographic that should answer some, if not all, of your questions:

This post was orginally here written by the Lexstart team.

 

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