SUMMARY
Raising Funding Via Convertible Notes Made Flexible
The Ministry of Corporate Affairs has made changes to the rules governing acceptance of deposits by companies. The move is expected to provide more flexibility for startups in raising funds, by increased flexibility and lesser procedural requirements.
The changes in the Companies (Acceptance of Deposits) Rule 2014, were made via a notification dated June 29, 2016.
As per the new rules, ‘an amount of twenty five lakh rupees or more received by a startup company, by way of a convertible note in a single tranche, from a person will not be considered as deposits under the companies law.’ These convertible notes however, must be convertible into equity shares or repayable within a period not exceeding five years from the date of issue.
A convertible note is an investment vehicle often used by seed investors investing in startups who wish to delay establishing a valuation for that startup until a later round of funding or milestone. Convertible notes are structured as loans with the intention of converting to equity.
However, for availing the benefit, the definition of a startup is the one as notified by the the Department of Industrial Policy and Promotion (DIPP).
As per DIPP a startup is a ‘company up to five years from the date of its incorporation only if its turnover for any of the financial years has not exceeded INR 25 Cr’.
So technically, a startup can avail this benefit, if it fulfills all the three conditions below-
- It was incorporated during FY 2011-12 and later, during the years
- It has earned a turnover less than INR 25 Cr
- It is working towards innovation, development, deployment or commercialisation of new products, processes or services driven by technology or intellectual property
Many startups that received funding, using the funds for more than a year was treated as a ‘deposit’ under the Companies Act, 2013. The existing provisions under the acceptance of deposit are very rigorous and come with a lot of clauses.
Prior to this in MArch 2016, DIPP issued a uniform definition of the word startup. Under the definition, a budding entrepreneur with a turnover of less than $3.6 Mn (INR 25 Cr) can avail tax breaks and other benefits for a five-year period.
