There is good news for all Indian startup entrepreneurs. The government of India has extended the timeline for startups to convert debt investment into equity shares by up to ten years, According to a press note from the DPIIT (Department for Promotion of Industry and Internal Trade).
Previously, Indian startups had up to five years to convert debt investments into equity shares, effective from the day when the initial convertible note was issued.
This new decision reflects the government’s desire to boost startups in India, as well as help early-stage startups in raising funds. In the last 10 years, startups have not only created jobs for millions of people in both rural and urban India, but also improved the country’s economic productivity by introducing innovative technologies, products, and services.
What is a convertible note?
An investor can invest in an early-stage startup through convertible notes. Convertible notes are one of the most popular short-term debt instruments, allowing investors to convert debt/loan into equity shares if the startup performs well or meets certain performance milestones in the future. Instead of receiving the money back with interest, investors receive shares of preferred stock as part of the startup’s initial preferred stock financing, based on the terms of the note.
“Extending such optionality to 10 years will help ease the burden on startups to prove the concept to early stage investors (especially in highly innovative cases requiring longer gestation for building scale) without triggering mandatory pre-mature exits. This policy move ought to enable a new generation of start ups too in raising seed capital /loan with better promise of retaining investments,” Sumit Singhania, Partner, Deloitte India, said.
On January 10, 2017, the RBI (Reserve Bank of India) amended the Foreign Exchange Management Regulations, 2000, allowing startups to issue convertible notes to foreign investors. Since then, convertible notes have grown in popularity as viable financing instruments for early-stage funding of startups.
Udaan, a B2B e-commerce startup, has closed a $250 million debt financing round in January 2022, by issuing convertible notes to primarily five new investors.
During the same month, Your-Space, a student housing startup, raised $10 million (roughly Rs 75 crore) in Series-A funding through a combination of pure equity and convertible debentures.
This new timeline change will give relief to all budding entrepreneurs in India who have suffered losses in their startups due to the Covid-19 pandemic and are now looking for the next round of funding.
Funding scenario in Indian startups
In 2021, investors have poured an unprecedented amount of money into Indian startups. Despite going through the Covid-19 pandemic, the startup ecosystem shattered all the previous fundraising records. According to Fintrackr data, the total amount of money invested in Indian startups in 2021 was close to $38 billion. Surprisingly, that’s more than three times more than the $11.1 billion in total funding received by startups in 2020.
Following the government’s extension of the timeline for converting debts into equity shares from 5 to 10 years, more startups are expected to raise funds through convertible notes.
