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START-UPS TIMELINE INCREASED TO 10 YRS FOR CONVERTING DEBT INVESTMENT INTO EQUITY

Context

The government has extended the deadline for companies to convert debt funding into equity shares by up to ten years, according to a news release from the DPIIT.

Key Points

  • This policy is likely to bring relief to emerging businesses grappling with the impact of the Covid-19 outbreak. Previously, convertible notes may be changed into equity shares for up to five years after they were issued. 
  • The time limit has been extended to ten years.

Policy features

  • Suppose the startup does well or fulfils certain performance standards in the future. In that case, the investor can ask the startup to offer equity shares in the firm in exchange for the money they had previously invested as a loan/debt.
  • According to experts, convertible notes have become increasingly feasible financing mechanisms for early-stage funding of enterprises since their inception in 2017.
  • According to Sumit Singhania, Partner, Deloitte India, convertible notes, unlike convertible debentures/debts, allow for optional conversion into equity without defining the conversion ratio in advance (and fewer regulatory covenants).

Extension

 

  • Extending this flexibility to 10 years will allow enterprises to exhibit their concept to early-stage investors without making required pre-mature exits (especially in highly innovative scenarios that require more gestation time to create scale). 
  • This shift would benefit startups in various industries, particularly those in the financial, educational, and retail sectors.

What is convertible debt?

  • One approach for an investor to invest in a startup is through convertible debt/notes, a sort of debt/loan instrument. 
  • According to the notice, 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,"

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