Convertible notes to Indian residents:
The concept of convertible notes was introduced in June 2016 when , the Ministry of Corporate Affairs (MCA) amended the Companies (Acceptance of Deposits) Rules, 2014 (Rules) exempting convertible notes from the ambit of deposits, and thereby allowing recognised startups to issue convertible notes in tranches exceeding Rs25 lakhs to prospective investors, without having to comply with the slew of requirements mandated by the Rules.
The Companies Act does not specifically mention that whether it can be issued to Indian Residents or Not. Going by that we are of the vies that the CN can be issued to Indian Residents.
Convertible Notes shall not be issued u/s 42 of the Act otherwise it will be a violation of the rule 14 made there-under or else the company will have to obtain valuation report which make no sense to raise money through convertible notes.
Company can issue Convertible Note under the provision of Section 62(3) of the Act (i.e. raising money as convertible debt) by passing Special Resolution and accordingly form MGT-14 should be filed with ROC within a period of 30 days.
Compliances when CN are issued to Indian Residents
The objective of convertible notes is to allow startups issue convertible instruments without having to go through a lot of compliances. The procedure to issue convertible notes is simple and does not involve any filing. ( No need to comply with private placement procedures)
The steps are:
- Convene a board meeting to approve the issue of CN
- Convene a EOGM to issue offer letter and approve CN agreement (No need to file MGT 14)
- Issue the CN to the investors.
The advantages of CN are:
- No private placement compliances required
- No valuation report required
- Optionally convertible
Accounting treatment for convertible notes:
Convertible Notes are recognised as debt in the books until they are converted or repaid.
Its not mandatory that interest be payable on the convertible notes. but generally companies for name sale pay a interest of 0.001% per annum on the total amount.
The convertible notes can be converted anytime upto 5 years maximum.