The government has extended the timeline up to ten years for startups to convert debt investments made in the company into equity shares, a decision likely to give relief to budding entrepreneurs to deal with the impact of the COVID-19 pandemic, according to a press note of the DPIIT.
Earlier, the option of changing convertible notes into equity shares was allowed for up to five years from the day of the issuing. Now that timeline has been extended to ten years.
An investor can invest in a startup through convertible notes — a kind of debt/loan instrument. But, in this investment, the investor is given the option of if the startup performs well or achieves some performance milestones in future, the investor can ask the startup to issue equity shares of the company against the money they had initially invested as a loan/debt.
“Convertible note means an instrument issued by a startup company acknowledging receipt of money initially as debt, which is repayable at the option of the holder, or which is convertible into such numbers of equity shares of such startup company, within a period not exceeding ten years from the date of issue of the convertible note, upon the occurrence of specified events as per the other terms and conditions agreed to and indicated in the instrument,” the note said.
According to experts, convertible notes have increasingly emerged as attractive financing instruments for early-stage funding of startups since its inception in 2017.
“Unlike convertible debentures /debts, convertible notes offer the flexibility of optional conversion into equity without having to determine the conversion ratio upfront (and fewer regulatory covenants),” said Sumit Singhania, Partner, Deloitte India.
“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 startups too in raising seed capital/loan with better promise of retaining investments,” Singhania said.
Rudra Kumar Pandey, Partner, General Corporate, Shardul Amarchand Mangaldas, said, “It seems the government wishes to extend the flexibility to the startup companies for appropriate valuation and conversion of the convertible note by additional five years until the startups are able to secure their next round of funding and to save them from the impact of COVID and liquidity issues.”
“Startups operating across the sectors will be benefited from this change, and particularly the startups in financial, educational, and retail sectors,” Pandey added.