According to a news release from the DPIIT, the government has extended the deadline for companies to convert debt financing into equity shares by up to 10 years, a measure that is likely to provide comfort to emerging enterprises dealing with the impact of the Covid-19 pandemic. Previously, convertible notes may be converted into equity shares for up to five years after the initial convertible note was issued. That time frame has now been increased to ten years.
- During the investment, the investor is given the option of asking the startup to issue equity shares in the firm in exchange for the money they had previously invested as a loan/debt if the startup does well or meets certain performance benchmarks in the future.
- Since its creation in 2017, convertible notes have become more viable financing vehicles for early-stage funding of businesses, according to experts.
- Convertible notes, unlike convertible debentures/debts, allow for optional conversion into equity without determining the conversion ratio ahead (and with fewer regulatory covenants), according to Sumit Singhania, Partner, Deloitte India.
- Extending this flexibility to ten years will make it easier for businesses to show their concept to early-stage investors (especially in highly inventive cases that require more gestation time to create scale) without having to make required pre-mature exits.
“This shift would benefit startups in a variety of industries, particularly those in the financial, educational, and retail sectors,” Pandey added.
What is convertible debt?
Convertible debt/notes, a type of debt/loan instrument, are one way for an investor to invest in a startup. “A convertible note is an instrument issued by a startup company acknowledging receipt of money initially as debt, which is repayable at the holder’s option, or convertible into such number 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,” according to the note.