Cautioning Indian startups about challenges with using convertible notes

India Investment
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Pitfalls of Using Convertible Notes Instruments in India

  • Convertible Notes widely used by startups in US/Silicon Valley ecosystem to defer valuation discussion
  • However, multiple limitations when trying to issue these in India due to regulatory restrictions:

Issuance Constraints

  • Only DPIIT registered startups allowed to issue convertible notes in India
  • And subsidiary entities prohibited from availing startup benefits, hindering use of mirror structures

Investor Rights Challenges

  • Convertible notes mandatorily need to convert to plain equity shares in India
  • Cannot establish preferential rights like liquidation preference for investor upon conversion
  • Redemption option also not available to investors in case of no conversion event

Dual Class Equity Structures Still Complex

  • Attempts seen to create dual class common shares for differential rights post conversion
  • But still very tricky to implement in India even for DPIIT certified startups
  • SAFE instrument not recognized at all under Indian company law frameworks
  • So traditional equity or compulsorily convertible debentures better structured instruments

Net net, while conceptually attractive, practically hard to issue clean convertible note from Indian startups without running into limitations or investor right concerns.