To boost up the Indian financial economy and to promote foreign investment in startup companies, the government introduces a concept of SAFE Notes in the form of Convertible Notes by amending the Companies Act, 2013 / related rules and Foreign Exchange (Transfer or Issue of Security by a Person Resident outside India) Regulations, 2000, w.e.f January 10, 2017, which allow Startup Companies to issue SAFE Notes in the form of Convertible Notes to an eligible Investor. Startup Companies use Convertible Notes to raise money in their early stages. It is a kind of financial instrument which consists of both debt as well as equity components. SAFE Notes in the form of Convertible notes may be issued to both person’s resident in India and persons resident outside India. SAFE Note means Simple Agreement for Future Equity. SAFE is an agreement between Investor and Investee Company whereby an Investor invests a certain amount in Investee Company on the terms and conditions mentioned in the SAFE Agreement. Invested amount is either repayable to investors or convertible in Equity Shares of the Investee Company on the happening of a certain event mentioned in SAFE Agreement or after expiry of a certain period.
As per rule 2(1)(c)(xvii) of The Companies (Acceptance of Deposits) Rules, 2014
Convertible Note means an instrument evidencing receipt of money initially as a debt, which is repayable at the option of the holder, or which is convertible into such number of equity shares of the start-up company upon occurrence of specified events and as per the other terms and conditions agreed to and indicated in the instrument.
Meaning of Startup Company
“Start-up Company” means a private company incorporated under the Companies Act, 2013 or Companies Act, 1956 and recognized as such in accordance with notification number 16[G.S.R. 127 (E), dated the 19th February, 2019 issued by the Department for Promotion of Industry and Internal Trade];
Difference between SAFE Notes and Convertible Bonds
Convertible Bonds and SAFE Notes in the form of Convertible Notes are very similar in nature. Both include debt as well as equity components. But the major difference is that SAFE Notes can only be issued by Startup companies.
Condition to be satisfied for issuing SAFE notes in the form of Convertible Notes by Startup
- Minimum value of Investment in single transaction is Rs. 25,00,000/- or more.
- Time period within which that Investment is converted into Equity shares is 5 years (increased to 10 years).
Points to Remember
- A person resident outside India (other than an individual who is a resident of Pakistan or Bangladesh or an entity or company which is registered and incorporated in Pakistan or Bangladesh), may purchase SAFE Notes from an Indian startup company.
- A startup company engaged in a sector where investment by a person resident outside India requires Government Approval, may issue SAFE Notes with prior permission of the Government. Issuance of equity share against such SAFE Notes shall be in compliance with direct entry route, sectoral caps, pricing guidelines and other attendant conditions for foreign investment.
- A startup company issuing SAFE Notes to a person resident outside India shall receive the amount of consideration by inward remittance through banking channel or by debit to the NRE/FCNR (B)/Escrow accounts maintained by the person in accordance with Foreign Exchange Management (Deposit) Regulation 2016. Repayment or sale proceeds also to be made through the same route by crediting to NRE/FCNR (B)/Escrow accounts.
- A Non-Resident or an overseas citizen of India may also acquire SAFE Notes through non-repatriation basis in accordance with Schedule 4 of these Regulations. A person resident outside India may acquire or transfer by way of sale, Convertible Notes, from or to a person resident in or outside India, provided the transfer takes place in accordance with the entry routes and pricing guidelines as prescribed for capital Instrument.
Reporting required under FEMA Act / RBI
The Indian startup company issuing SAFE Notes in the form of convertible notes to persons resident outside India shall report such inflow to the Authorized dealer bank within 30 days of receipt of funds against issue of such SAFE Notes.
Consequences of delay in reporting
If delay in reporting to authorized dealer bank as per the time prescribed by RBI then person shall be liable for payment of late fees. The payment of late submission fees is an additional option for regularizing reporting delays without undergoing the compounding procedure. Amount of late submission fees is changed from time to time by the RBI after consultation with the Central Government.
Concept of SAFE Notes is relatively new in India and gaining momentum. A key feature of these policy announcements has been to boost fundraising options for startups by permitting startups to raise funds through issuance of SAFE Notes which was earlier not allowed. This policy relaxation will help innovative startups raise capital in their initial stage and explore funding opportunities with both domestic and foreign investors. The crux of this policy is to attract foreign investors towards investing in India.
About the Author: This article is contributed by CA Rajeev Gupta, Partner – SIGMAC & Co, Chartered Accountants, Location- Delhi NCR and Gurgaon.
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