Start-ups to get 5 more years to convert ‘convertible notes’ into equity shares

Start-ups will now get five more years to convert convertible notes into equity shares. This is one of various changes in Foreign Exchange Management (Non-debt Instruments or NDI) Rules, 2019, notified by the Finance Ministry.

Another important change intends to allow an Indian company to issue share-based employee benefit to a person outside India. These amendments are consequent to a change in FDI policy for permitting foreign investment in LIC and other modifications.

More flexibility

Under the present structure of rules, a convertible note is an instrument issued by a start-up company acknowledging receipt of money, initially as debt, repayable at the option of the holder, or which is convertible into such number of equity shares of that company within a period not exceeding five years. Now, the five years have been changed to ten year.

Yashojit Mitra, Partner with Economic Laws Practice, said the change “gives more flexibility to structure investments though the venture debt route.”

Nischal S Arora, Partner (Regulatory) with  Nangia Andersen LLP, said, “This decision is likely to benefit start-ups that raise funds from investors who may want additional cushion for their investments by keeping them as debt for a longer duration.”

Clarifying “real estate business”

The definition of “real estate business” has also been aligned and harmonised.

Now, “real estate business” means “dealing in land and immovable property with a view to earning profit from there and does not include development of townships, construction of residential or commercial premises, roads or bridges, educational institutions, recreational facilities, city and regional level infrastructure, townships, real estate broking services and Real Estate Investment Trusts (REITs) and earning of rent or income on lease of the property, not amounting to transfer.”

Mitra said that amendment now provides that dealing in land and immovable property with a view to earning profit from there will be considered “real estate business”. 

“The earlier exclusions have been retained and it has been specified that registered and regulated REITS earning rent or income on lease of property, not amounting to transfer will not be considered as real estate business”,” he explained.

Further, Arora said that earlier there used to be two definitions of “real estate business” — one under list of prohibited sectors and another under permitted sectors. 

“The two definitions have now been aligned for removal of doubt and provide clarity,” he said.

Share-based employees benefit

Another key amendment allows an Indian company to issue share-based employee benefits besides employees’ stock option and sweat equity shares to its employees or directors, or employees or directors of its holding company or joint venture, or wholly owned overseas subsidiary or subsidiaries resident outside India.

Share-based employees benefit includes concepts such as restricted stock units. Under such a mechanism, a company issues its equity shares to an employee subject to certain restrictions (such as vesting period) or fulfilment of prescribed performance conditions.  

Widening scope

Giving a sense of overall change, Mitra said these introduce opportunities for foreign investment in the Life Insurance Corporation of India to up to 20 per cent under the automatic route but subject to the provisions under the LIC Act and the Insurance Act. Many other incidental amendments have also been included which are cover not only companies under the Companies Act, 2013, but also exten to body corporates established or constituted under Central or State Act, which are incorporated in India.

“This widens the scope of operations of the NDI Rules,” he said.

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