In May 2025, a Bengaluru-headquartered payments-and-fintech company completed the largest reverse flip in Indian startup history, shifting its parent domicile from Delaware to India ahead of a domestic IPO. The tax cost ran into the range of $200 million. The structural cost was bigger: every Y Combinator SAFE, every convertible note, every preference share issued during the Delaware years had to be redrafted, re-stamped, and re-papered into Indian instruments under the Companies Act, 2013, and the FEMA Non-Debt Instruments Rules. This was the visible end of a deeper structural shift in how Indian founders pick instruments at the very first cheque, and it is what makes the convertible notes and SAFE agreements India framework the single most consequential drafting decision at pre-seed today.
The pattern repeats up and down the cap-table. A consumer-fintech that completed its India flip in 2022 paid roughly $1 billion in capital gains to do it. A discount broker that flipped back in May 2024 paid around $160 million. The pattern in every case is the same: the SAFE that was simple to sign in San Francisco at pre-seed becomes the SAFE that costs nine or ten figures to unwind at the IPO door. Pre-seed founders who watched these numbers ran the math in the other direction, and started the next deal on an Indian convertible note or an iSAFE-structured CCPS instead.
The regulatory inflection was 23 July 2024. In the Union Budget speech, the Finance Minister announced the abolition of Section 56(2)(viib) of the Income Tax Act, 1961, ending the so-called “angel tax” that had hung over closely held company fundraises since 2012. The provision had taxed any excess of issue price over fair market value at the slab rate, and for everyone outside the DPIIT exemption process it had been a friction tax that pushed founders offshore. Twelve months after abolition, the Indian convertible note has become the default pre-seed instrument for domestic and cross-border deals alike, sitting alongside the iSAFE for the sub-₹25 lakh syndicate cheques the convertible note’s threshold locks out.
The iSAFE itself arrived earlier. In July 2019, a SEBI-registered Category I Alternative Investment Fund became the first Indian institutional investor to deploy a SAFE-style instrument, structured as compulsorily convertible preference shares to satisfy Sections 42, 55 and 62 of the Companies Act, 2013. Roughly ₹1.25 crore per cheque, 15 percent post-conversion equity, a template that has since been adopted across the angel-network and micro-VC ecosystem. The iSAFE is not a translation of the Y Combinator SAFE. It is a different instrument that gets the SAFE’s commercial logic (no maturity, valuation cap, discount) into a form Indian corporate law actually recognises. That distinction is the single most important thing a founder needs to grasp before signing one.
The 2025 numbers tell the rest. Indian startups raised roughly $11 to $13 billion across the year, with 552 pre-seed and seed rounds closing inside it. Median pre-seed cheques sat in the $200,000 to $500,000 band. Most landed on either a convertible note, an iSAFE, or a priced CCPS round. Get the instrument right at pre-seed, and the founders walk into Series A with three to seven percent more of the cap table than they would on a sloppy term sheet. Get it wrong, and the conversion math, the DPIIT cliff, or the FEMA filings surface as friction at exactly the worst moment. What follows is the drafting and regulatory map a pre-seed founder, or the junior corporate associate drafting their first convertible note for one, actually needs.
A convertible note in India is a debt instrument issued by a DPIIT-recognised startup that converts into equity on a qualifying event, with a minimum investment of ₹25 lakh per investor in a single tranche and a maximum tenure of 10 years from issuance. SAFE agreements are not directly issuable in India; founders use iSAFE notes structured as compulsorily convertible preference shares (CCPS) instead.
The drafting choices behind that paragraph, which clauses to include, where the Companies Act and FEMA require specific disclosures, and how the conversion math actually plays out in rupees, are what separate a clean cap table at Series A from an investor dispute at the NCLT.
What a convertible note is in India, and why pre-seed founders use it
At pre-seed, the company has no operating history a valuer can rely on. There is a product idea, a team, sometimes a prototype, occasionally a handful of paying users. Anyone trying to set a defensible price-per-share at that stage is performing a ritual, not a valuation. The convertible note is the legal answer Indian regulators built for that exact problem.
How a convertible note works: debt-then-equity mechanics
A convertible note begins life as a debt instrument. The investor wires money. The company books a liability. Interest, if any, accrues. Then a defined trigger event (usually the company’s next priced equity round above an agreed floor) flips the liability into equity at a pre-agreed conversion price. The conversion price typically comes through either a valuation cap or a discount to the next round’s price, or whichever yields more shares to the investor.
The legal definition lives in Rule 2(1)(c)(xvii) of the Companies (Acceptance of Deposits) Rules, 2014: a convertible note is an instrument acknowledging receipt of money initially as debt, repayable at the option of the holder, or convertible into equity shares of the startup company within a maximum of 10 years from issue, upon occurrence of specified events. The “at the option of the holder” language is doing real work here, and we’ll return to it in the section on conversion, disputes and the Sutanu Sinha effect when we look at how Indian insolvency courts read the optionality.
What experienced practitioners know is that the optional-repayment feature is what distinguishes a convertible note from a compulsorily convertible debenture. A CCD must convert. A CN can convert, or be repaid, depending on what happens at maturity. That single binary determines whether the instrument behaves like debt or equity in a dispute.
Why pre-seed founders pick convertible notes over priced equity rounds
The short answer: speed and dilution control. A priced equity round at pre-seed requires a valuation report from a registered valuer, due diligence proportionate to the round size, a shareholders’ agreement, an amended articles of association, FEMA pricing-guideline compliance if a foreign investor is in the room, and a board plus shareholder approval process. Realistically, eight to twelve weeks from term sheet to closing on a clean deal.
A convertible note compresses that into two to four weeks. No valuation report (Section 56(2)(viib) doesn’t bite because the company isn’t issuing shares at issuance; we’ll cover the post-2024 angel tax position in the Indian regulatory map section below). No SHA. No amended AOA. Just the convertible note agreement, the board and special resolutions, the MGT-14 filing, and (for foreign-investor cheques) Form CN to the AD bank.
The dilution control angle matters even more. At pre-seed, a founder who issues equity is locking in a valuation that the market will mark to the floor at every subsequent round. A founder who issues a convertible note defers that price discovery to a later round where the company has real data points. Bottom line: the seller of the equity is in a much stronger position to defend the price six months later than two weeks after incorporation. Can a convertible note also serve as a bridge between two priced rounds? Yes, and that’s a common second use case (the bridge note before Series A), though the drafting concerns shift slightly.
What a convertible note is not: venture debt, CCDs and CCPS
[HISTORICAL] The convertible note as a defined Indian instrument is younger than most founders assume. The Ministry of Corporate Affairs introduced it via a 29 June 2016 notification that amended the Companies (Acceptance of Deposits) Rules, 2014. Before that notification, Indian startups had to use CCDs or CCPS for SAFE-equivalent fundraising. The original tenure cap was five years. In 2023, the FEMA Non-Debt Instruments Rules amendment pushed the cap to ten years, and the Deposit Rules followed.
Venture debt is a different animal. Venture debt is a term loan from a regulated NBFC or bank against the company’s runway and the back-stop of the next priced round, with interest, security, and amortisation. It does not convert. A CCD must convert (no holder option to redeem in lieu of conversion). CCPS converts mandatorily into equity shares at the conversion ratio set at issuance. The convertible note sits between all three: convertible like CCDs, optional like a redeemable debenture, faster to issue than CCPS. Worth flagging: confusing a CN with a CCD at drafting stage is one of the more expensive mistakes a junior corporate associate can make, and we’ll see why in the dispute-classification section further down.
So which one wins at pre-seed? The CN beats the alternatives on speed and on optionality. CCPS wins when both parties want certainty of conversion and the company has enough data to set a number. The founder’s decision is rarely “convertible note vs equity”; it’s “convertible note now vs CCPS at a slightly higher valuation in three months”. For most pre-seed teams, the answer is the CN.
What is a SAFE agreement and is it legal in India
This is where the most founder confusion lives. The SAFE that Y Combinator published in late 2013 (and revised to post-money in 2018) was designed for the US Delaware corporate framework, where equity issuance is fast, cheap, and lightly regulated. In India, none of those three assumptions hold.
Why a SAFE is not directly issuable under the Companies Act, 2013
The Y Combinator SAFE is a contractual right to receive equity on a future trigger event. It is not a debt instrument. It is not a debenture. It is not a preference share. It is not a convertible note as defined by Indian law. Under Section 2(31) of the Companies Act, 2013, a “share” is share capital divided into shares of fixed nominal value. The SAFE issues no shares on day one and carries no fixed nominal value. Under Section 42 of the Companies Act, 2013, a company that issues securities via private placement must do so through a defined instrument issued in a regulated process. SEBI regulations and the FEMA NDI Rules build on the same architecture. The SAFE, as drafted by Y Combinator, fits none of these slots.
What’s the consequence? A SAFE signed on a Y Combinator template against an Indian private limited company is, on a strict reading, a contract that promises something the issuer cannot lawfully deliver in the form contemplated. Indian courts have not directly ruled on a pure-form SAFE (the question hasn’t reached a final reported decision). But practitioners (and the academic commentary from NLIU’s Centre for Business and Commercial Laws and other research desks) are uniformly cautious: the original SAFE is not recognised under Indian corporate or securities law. Adopt it at your own risk.
In practice, the result is that no serious Indian counsel will paper a foreign or domestic deal on the unmodified Y Combinator SAFE. The template gets re-engineered into one of two compliant wrappers: either a convertible note (if the investor wants debt-like protection) or an iSAFE (if the investor wants equity-like simplicity).
How iSAFE solves the problem: CCPS as the legal wrapper
The iSAFE is the Indian-law equivalent of the SAFE. It was published by 100X.VC, a SEBI-registered Category I Alternative Investment Fund, in July 2019, and is now the de facto template in the Indian pre-seed market. The crucial structural move: an iSAFE is issued as compulsorily convertible preference shares under Section 55 of the Companies Act, 2013, read with Rule 9 of the Companies (Share Capital and Debentures) Rules, 2014, not as a free-floating “future equity” right.
CCPS have a fixed nominal value, carry a non-cumulative preferential dividend (typically 0.0001 percent, a token figure designed to satisfy the statutory requirement that preference shares carry a preferential dividend), and convert mandatorily into equity at a pre-agreed conversion ratio or formula. The iSAFE keeps the SAFE’s commercial logic (valuation cap, discount, no maturity date) while dressing the instrument in CCPS clothing for Indian regulatory compliance.
Two practical limits to flag. First, only a company can issue CCPS. Partnership firms and LLPs cannot. If the startup is an LLP, iSAFE is off the table; either convert to a private limited company first, or use a different instrument. Second, post-money vs pre-money matters. The iSAFE template tracks the Y Combinator post-money SAFE, which is the cleaner of the two for cap-table modelling. Founders who have read older SAFE commentary based on the pre-money version should re-read the iSAFE before signing.
When founders should reach for iSAFE instead of a CN
There are four common moments. First, when the lead investor is a 100X-style AIF or angel network that prefers the iSAFE template and refuses to redraft as a CN. Second, when the founders want to avoid any debt-classification risk in subsequent insolvency or restructuring scenarios (the iSAFE is equity from day one). Third, when the cheque size is small (₹10 to 20 lakh per investor) and the ₹25 lakh single-tranche minimum for a CN under the Deposit Rules is a hard block. And fourth, when the cap-table modelling is cleaner with a known conversion ratio than with optionality.
The flip side: an iSAFE doesn’t sit perfectly under FEMA for foreign-investor deals (the FEMA NDI Rules recognise convertible notes and CCPS, but the iSAFE’s specific structure can create reporting questions). For a cross-border pre-seed deal, the convertible note is still the safer pick. Most market participants have made peace with the rule of thumb: domestic pre-seed deals tend toward iSAFE; cross-border pre-seed deals tend toward CN.
Is the “most-favored-nation” clause enforceable in an Indian iSAFE? The clause itself is contractual, so yes, the contract is enforceable between the parties. But the MFN’s downstream effects on subsequent investor terms must be papered into the SHA at conversion, otherwise the protection evaporates at the moment it matters.
The Indian regulatory map: Companies Act, FEMA and Income Tax
This is the spine of the whole post. Every drafting decision and every founder negotiation defaults back to these four statutes plus the regulator-issued rules underneath them.
Companies Act, 2013: Section 62(3), Section 42 and the Deposit Rules carve-out
Three sections do most of the heavy lifting. Section 62(3) of the Companies Act, 2013 is the gateway for issuing convertible securities on terms agreed with the lender, and it requires a special resolution. Section 42 regulates the private placement framework for issue of securities to identified persons; the Section 42 process applies to CCPS issuances under an iSAFE structure and to non-CN equity issuances generally. The Companies Act’s Deposit Rules (Companies (Acceptance of Deposits) Rules, 2014, hereinafter “Deposit Rules”) would, by default, treat money received by a private company from non-shareholders as a deposit, with all of the public-deposit regulatory baggage that comes with that classification.
The carve-out under Rule 2(1)(c)(xvii) of the Deposit Rules is what makes the convertible note workable. The rule says: an amount of ₹25 lakh or more, received by a startup company in a single tranche from a person, by way of a convertible note that is convertible into equity or repayable within 10 years from issue, is treated as an “exempted deposit”. Translation: it doesn’t count as a deposit for the regulatory framework’s purposes. The startup must hold valid DPIIT recognition at the time of issue.
What experienced practitioners know is that the carve-out’s three conditions are all hard gates, not soft guidelines. Lose DPIIT recognition between issue and conversion, miss the ₹25 lakh single-tranche minimum, or breach the 10-year tenure, and the instrument flips from convertible note to regulated deposit. The founder-mistakes section further down covers why the DPIIT cliff is the trap almost no one anticipates.
FEMA Non-debt Instruments Rules, 2019: Rule 9 and Form CN
For foreign-investor convertible notes, the operative regulation is Rule 9 of the Foreign Exchange Management (Non-Debt Instruments) Rules, 2019. The rule permits a person resident outside India (other than a citizen or entity of Pakistan or Bangladesh) to subscribe to a convertible note issued by an Indian startup company, provided the amount is ₹25 lakh or more in a single tranche and the instrument complies with the Companies Act framework above.
The 2023 amendment to the NDI Rules harmonised the FEMA tenure with the Deposit Rules at 10 years. The Deposit Rules had moved to 10 years earlier; the NDI alignment was the missing piece. Before that amendment, foreign-investor CNs were stuck at the FEMA 5-year tenure even though domestic CNs could go to 10.
Form CN is the reporting instrument. The startup must file Form CN with the RBI through an Authorised Dealer (AD) bank within 30 days of issue. On conversion of the CN into equity shares, Form FC-GPR is filed within 30 days of share allotment. Get either timing wrong and the FEMA compounding window opens, which is solvable but costs money and time.
Sectoral caps interact at the moment of conversion, not at issuance. If the company operates in a sector that requires government approval for foreign investment (defence, telecom, broadcasting), the CN issuance itself needs prior government approval. Get this analysis wrong at term-sheet stage and the deal collapses at conversion.
Income Tax: what 2024’s angel-tax abolition actually changed
[HISTORICAL] Until the Finance Act 2024, Section 56(2)(viib) of the Income Tax Act, 1961 (the so-called “angel tax”) taxed any excess of consideration received by a closely held company on issue of shares over the share’s fair market value as the company’s income from other sources, at the slab rate. For DPIIT-recognised startups, an exemption was available through the DIPP/DPIIT notification process; for everyone else, the section was a meaningful friction on pre-seed and seed rounds, particularly when foreign investors were in the round and the FMV calculations diverged from market reality.
The Finance Act 2024 made Section 56(2)(viib) inapplicable for any consideration received on or after 1 April 2025. The angel tax, in its general form, is gone. What remains, and what most founder-facing articles still get wrong, is that Section 56(2)(x) (receipt of property below FMV in the recipient’s hands) can still bite at conversion if the equity allotted is significantly below the fair value implied by the next round’s pricing. The conversion event creates a receipt-of-shares moment for the investor, and the tax officer can revisit the discount and cap mechanics if the math is unusually aggressive.
The other relevant provision is Section 47(xb) of the Income Tax Act, 1961. On conversion of CCPS into equity shares, no capital gains tax arises for the holder. The same exemption logic underlies the iSAFE’s tax efficiency at conversion: the holder converts CCPS into equity without a tax event, and the eventual tax accrues only on a later transfer of the equity shares at fair value above cost.
SEBI and the AIF angle
When the investor is a SEBI-registered Alternative Investment Fund (most micro-VC funds in the Indian pre-seed ecosystem are Category I AIFs), additional SEBI rules under the SEBI (Alternative Investment Funds) Regulations, 2012 apply to the AIF’s side of the deal, not to the startup directly. The AIF’s investment limits, asset-allocation rules, and reporting obligations are all on the AIF; the startup’s drafting concerns end at the CN or iSAFE agreement.
But two cross-references matter for the founder. First, an AIF investing through a CN must maintain investee diversification limits; that affects how much one AIF can put into a single CN. Second, AIF-side disclosures may require the startup to provide quarterly or semi-annual financial statements during the CN’s life. Build the information-rights clause in the CN agreement with that downstream requirement in mind, and the AIF will not have to chase the company for the same data every quarter.
Who can issue a convertible note in India: the DPIIT gate
The DPIIT recognition certificate is the entry ticket. Without it, the convertible note carve-out under the Deposit Rules doesn’t apply, the instrument becomes a regulated deposit, and the company is in immediate non-compliance.
DPIIT recognition criteria after the 2025 turnover-limit revision
The eligibility criteria for DPIIT recognition under the Startup India framework are now: incorporation as a private limited company, registered partnership firm, or LLP under Indian law; period of existence and operations not exceeding 10 years from the date of incorporation; annual turnover not exceeding ₹200 crore (raised from ₹100 crore in 2025) in any financial year since incorporation; working toward innovation, development, or improvement of products, processes, or services, or with a scalable business model with high potential for employment generation or wealth creation; and not formed by splitting up or reconstruction of an existing business.
A sub-category for “Deep Tech Startups” carries a higher turnover ceiling of ₹300 crore and an extended age limit of 20 years. Most pre-seed startups land comfortably inside the standard category; the deep-tech track tends to matter at Series A and beyond, not at pre-seed.
The application is online through the Startup India portal, and the recognition certificate is typically issued within two to four weeks of a clean filing. We’d recommend treating the certificate as a hard prerequisite at term-sheet stage: do not sign a convertible note before the certificate is in hand, and verify the DPIIT registration number against the issuing portal.
The ₹25 lakh single-tranche minimum, and why it locks out small angel cheques
Rule 2(1)(c)(xvii) requires that the convertible note be issued for ₹25 lakh or more per investor in a single tranche. That single sentence has reshaped angel-investor behaviour in the Indian pre-seed market.
A founder who wants to raise ₹50 lakh from three angels at ₹10 lakh, ₹15 lakh, and ₹25 lakh per cheque cannot use the convertible note carve-out for the first two. The ₹10 lakh and ₹15 lakh cheques fall below the threshold, and the structure for those would have to be either a priced CCPS round (cleaner but slower) or an angel syndicate that pools the small cheques behind one nominee that meets the ₹25 lakh minimum on the cap table.
[SECOND-ORDER] The downstream consequence has been the proliferation of angel-syndicate platforms in the Indian pre-seed market. AngelList India, LetsVenture, Inflection Point Ventures, and a dozen smaller syndicates have built their business model around aggregating sub-₹25 lakh cheques into a single nominee on the cap table. The syndicate structure adds a layer of paperwork (the syndicate agreement, the nominee structure, the carry-and-management-fee economics) but unlocks the convertible note carve-out. For founders raising from a wide angel base, the syndicate route is now the default.
What happens if a startup loses DPIIT recognition before conversion
Three scenarios trigger DPIIT recognition loss: the 10-year incorporation cap is crossed; turnover crosses ₹200 crore; or DPIIT itself revokes recognition on a compliance review (rare, but possible).
If DPIIT recognition lapses while a convertible note is still on the books and has not yet converted, the instrument loses the Deposit Rules exemption. From the date of lapse, the CN is treated as a deposit, and the company must comply with the deposit framework’s requirements (advertisement, credit rating, deposit insurance) within statutory timelines. In practice, most companies in this scenario either convert the CN immediately or repay it.
The cleanest drafting answer is a covenant in the CN agreement that the company will maintain DPIIT recognition through the life of the instrument or, failing that, will either convert or repay within a defined cure period (typically 30 to 60 days from loss of recognition). Without that covenant, the holder is left to negotiate the cure post-lapse, which is a bad place to be.
How to draft a convertible note in India: clause-by-clause
This is the section every founder and junior drafter actually came here for. We’ll walk the agreement top to bottom, with the drafting decisions that matter and the ones that don’t.
The pre-drafting checklist
Before the first word of the CN agreement is drafted, four documents need to be on the desk. First, the DPIIT recognition certificate, with its validity confirmed against the Startup India portal. Second, the signed term sheet between the company and the lead investor, recording the commercial terms (amount, cap, discount, maturity, interest). Third, the company’s current cap table, including all SAFE-equivalents and ESOP grants outstanding, so the conversion math at the next round can be modelled. Fourth, the company’s articles of association, to confirm that the AOA permits issuance of convertible securities under Section 62(3) and does not require shareholder consent beyond what the Companies Act prescribes.
If the term sheet contemplates foreign investment, two more pre-conditions: confirm the sectoral classification (automatic route vs approval route) and identify the AD bank that will handle the Form CN filing. The cap-table cleanup is the highest-leverage pre-drafting step. Bringing the co-founder agreement drafting guide up to date before issuing a CN protects against later disputes about ownership and reserved matters.
Parties, recitals and definitions
The parties clause lists the company and each subscriber, with full corporate identity (CIN, registered address, PAN) for corporate parties and full identification (name, address, PAN, nationality) for individual investors. For foreign subscribers, passport or equivalent identification and country of tax residence.
Recitals frame the commercial intent in three or four sentences: the company’s DPIIT-recognised status, the investor’s interest in subscribing to a convertible note under Section 62(3) of the Companies Act, and the commercial terms agreed in the term sheet (referenced by date, not reproduced).
Definitions are where most under-experienced drafters cut corners and senior drafters obsess. The definitions that matter most: “Qualified Financing” (the conversion trigger), “Conversion Price” (the price at which the CN converts), “Valuation Cap”, “Discount Rate”, “Maturity Date”, and “Event of Default”. Each of these needs a precise definition. We’ll cover the qualified-financing definition under the conversion-clause subsection below because it’s the single most-fought-over drafting clause.
Investment amount, tranches and disbursal mechanics
The investment amount clause states the principal subscribed by each investor. For a multi-investor CN, each investor’s amount is set out individually, with a clear single-tranche structure to satisfy the ₹25 lakh threshold per investor.
Multi-tranche disbursal is tricky. If the term sheet contemplates two or three tranches against milestones (₹25 lakh on signing, ₹25 lakh on MVP launch, ₹25 lakh on first revenue), the Deposit Rules treatment depends on whether each tranche is a separate convertible note. The cleaner structure is to issue one CN per tranche, each meeting the ₹25 lakh single-tranche minimum. Trying to draft a single CN with a tranched draw-down feature creates ambiguity about whether the second and third tranches qualify for the exemption. We’d recommend the multi-CN structure; it’s cleaner regulatorily and easier to enforce commercially.
Disbursal mechanics: bank-account details, the date by which each tranche must be funded, the consequence of late funding (usually the CN does not come into effect until the principal is received in the company’s account). For foreign investors, the disbursal must come through the AD bank with the FIRC (Foreign Inward Remittance Certificate) preserved for the Form CN filing.
Conversion clause: qualified financing definition, automatic vs optional triggers
The conversion clause is the heart of the agreement. Two questions to answer: what event triggers conversion, and how is the conversion price calculated.
“Qualified Financing” is the event. The clean definition has three elements: a minimum aggregate investment amount (usually ₹3 crore to ₹15 crore depending on company stage), an instrument type (Series A Preferred Stock, or equivalent CCPS), and an investor profile (typically excluding existing CN holders and friends-and-family rounds). The worst drafting move is to define qualified financing as “the next round of equity financing of the Company” without quantifying it. That definition lets a small bridge round trigger conversion at the wrong price, which is exactly the failure mode US practitioners have written about for fifteen years.
Automatic vs optional conversion is the other core choice. An automatic-conversion CN converts on the qualified-financing event whether the holder wants it to or not. An optional-conversion CN gives the holder a choice (convert, or be repaid). The M/s IFCI Limited v. Sutanu Sinha & Ors., 2023 INSC 1023 framework (which we’ll unpack in the dispute-classification section further down) treats automatic conversion as a signal of equity classification and optional conversion as a signal of debt classification. For convertible notes, which by definition include an option to repay, the instrument is closer to debt. The drafting move is to make this explicit: if the holder chooses to be repaid at maturity, the CN was always debt; if the holder elects to convert at qualified financing, the conversion event is the equity-issuance moment.
Valuation cap and discount rate: drafting both, picking one
The two conversion-price mechanisms are the valuation cap and the discount rate. The valuation cap sets a ceiling on the implied pre-money valuation at which the CN converts. The discount rate gives the holder a percentage discount to the qualified-financing round’s per-share price. The standard market practice in India is to include both, with a “better-of” mechanism: the holder converts at whichever yields the lower conversion price (and therefore more shares).
Typical Indian pre-seed ranges: valuation caps of ₹4 to 12 crore depending on stage and team strength, discount rates of 15 to 25 percent. The lower-cap end is for first-time founders and very early-stage products; the higher-cap end is for repeat founders or post-traction MVPs.
[SECOND-ORDER] The “better-of” mechanism almost always favours the investor and almost always costs the founder one to three percent of cap-table dilution at the conversion event. That is the price the founder pays for not setting a number at issuance. Founders who push back hard on the cap (often the lever where they have the most room) save more cap-table than founders who push back on the discount. The cap is the load-bearing variable; the discount is the rounding error.
The drafting move: cap and discount get their own sub-clauses with explicit formulas. We’ve seen drafts that mix both into a single conversion-price sentence; that ambiguity costs the founder when the math is run at conversion. Worth flagging: founders in some recent term sheets have negotiated a “discount with no cap” or “cap with no discount” structure. Both work; the better-of just falls away. Pick the structure that matches the commercial reality of the relationship.
Interest, maturity and the repayment fallback
Indian convertible notes typically carry interest at 5 to 8 percent per annum, simple interest, accrued but unpaid until conversion or maturity. The interest accrues to the principal at conversion, increasing the share count the holder receives.
Maturity dates of 24 to 36 months are now the market standard for Indian pre-seed CNs. The 10-year cap in the Deposit Rules and the FEMA NDI Rules is the regulatory ceiling; commercial maturities are far shorter. Long maturities are rare and signal a holder who is patient with the company’s growth trajectory.
The repayment fallback matters when the qualified-financing trigger never fires. Three options: (1) automatic conversion at maturity at a defined price (typically the valuation cap or a pre-agreed fixed price), (2) holder option to convert at the same price or be repaid, (3) holder option to extend maturity. Most Indian CNs use option (2). Be careful here: if the holder elects repayment at maturity and the company doesn’t have the cash, the CN becomes a non-performing instrument and the holder can trigger remedies. The drafting move is to align the repayment fallback with the company’s expected runway, and to build a cure period (60 to 90 days from maturity) into the agreement.
Can investors force conversion at maturity if the startup hasn’t raised? Only if the agreement gives them that explicit right. Most pre-seed CNs leave the holder with the option to convert at a default conversion price, not to force a priced round. Loud lesson: read your maturity clause carefully before you sign.
Representations, warranties, anti-dilution and information rights
Founders’ reps and warranties at pre-seed are deliberately light: due incorporation, capitalisation as represented, no undisclosed liabilities, IP ownership, no material litigation. The investor’s reps and warranties are even lighter: power to subscribe, authority of signatory, no adverse holding.
Anti-dilution protection in an Indian pre-seed CN is unusual but increasingly seen. The two flavours: full-ratchet (the conversion price ratchets to the lowest subsequent issuance price, full protection for the holder, brutal for founders) and weighted-average (the conversion price adjusts to a weighted average of the CN price and the subsequent issuance, balanced protection). If anti-dilution is in the agreement at all, push for weighted-average. Full-ratchet at pre-seed is an investor over-reach.
Drag-along and tag-along rights are typically deferred to the SHA at the qualified-financing round. Pre-seed CN agreements rarely contain these clauses because the company is too early for an exit scenario to be meaningful. But information rights (quarterly financial reports, annual audited statements, board-meeting observation rights for the lead investor) are common and should be in the CN agreement.
Boilerplate that matters: governing law, arbitration seat, notices
Governing law: Indian law, specified expressly. Jurisdiction: courts of a specific city (Bangalore, Mumbai, Delhi, or Gurgaon, matching the company’s registered office). Arbitration: the cleaner approach is to provide for institutional arbitration under MCIA (Mumbai Centre for International Arbitration) or DIAC (Delhi International Arbitration Centre) for domestic deals, and SIAC for cross-border deals.
Notices: physical and electronic, with a defined notice-to-respond window. Confidentiality: standard one-year tail. No-shop: optional but useful, restricting the company from raising additional CN cheques on better terms during the lead investor’s signing process.
The boilerplate is where junior drafters under-invest the most, and where senior drafters earn their keep. The arbitration-seat choice alone can determine whether a future dispute costs ₹2 lakh or ₹50 lakh in legal fees.
Conversion math: a worked example in rupees
Theory is one thing. Watching the numbers move in actual rupees is another. Here’s the worked example every pre-seed founder should be able to do on the back of a napkin.
The setup
Assume a company issues a ₹50 lakh convertible note to one investor. The cap is ₹6 crore pre-money. The discount is 20 percent. There is no interest (for simplicity; add it as 7 percent annual if you want a richer model). Maturity is 24 months. The qualified financing round closes 14 months later at ₹12 crore pre-money valuation. The new investors put in ₹4 crore for a 25 percent post-money stake. The founder’s pre-CN cap table held 100 percent (sole founder, 10 lakh shares, face value ₹10 each, paid-up share capital ₹1 crore).
Path A: convert via the valuation cap
Path A asks: how many shares does the CN holder get if the cap is the binding mechanism?
The cap-implied conversion price per share is the cap value divided by the fully-diluted share count at the time of CN issuance. At issuance, the company had 10 lakh shares outstanding. So the cap-implied price per share is ₹6 crore divided by 10 lakh shares, which is ₹60 per share.
The CN principal is ₹50 lakh. At a conversion price of ₹60 per share, the CN converts into ₹50 lakh divided by ₹60, which is 83,333 shares. After conversion, the company has 10,83,333 shares outstanding before the Series A new shares are issued.
Path B: convert via the discount rate
Path B asks the same question with the discount as the binding mechanism.
The qualified-financing per-share price is the Series A pre-money valuation divided by the pre-Series-A fully-diluted share count. The new investors paid ₹4 crore for 25 percent post-money, implying a post-money valuation of ₹16 crore and a pre-money of ₹12 crore. The pre-Series-A share count (post-CN-conversion if we were converting via Path A) is 10,83,333. So the Series A per-share price is ₹12 crore divided by 10,83,333, which is approximately ₹110.77 per share.
The 20 percent discount brings the CN conversion price down to ₹110.77 multiplied by 0.80, which is ₹88.61 per share. The CN principal of ₹50 lakh divided by ₹88.61 per share gives the holder approximately 56,427 shares.
The “better-of” mechanism and why it favours the investor
Compare the two paths. Path A (cap) gives the holder 83,333 shares. Path B (discount) gives the holder 56,427 shares. The cap is the binding mechanism in this scenario: the holder gets more shares (lower conversion price, more dilutive to founders) through the cap path.
That is exactly the founder’s worst case. The cap and the discount don’t stack: the holder takes the better-of, not both. So the founder’s negotiation lever is the cap. A cap of ₹6 crore against a Series A pre-money of ₹12 crore means the CN converts at half the Series A price, which is 100 percent better than the un-capped 20 percent discount path. That’s the math behind why every senior practitioner advises founders to negotiate the cap hardest, and why every senior practitioner advises investors to take the cap-plus-discount-better-of structure.
Worth flagging the ESOP-pool interaction: if the Series A round expands the ESOP pool from 5 percent to 12 percent on a pre-money basis, the conversion math shifts again. The dilution from the ESOP-pool expansion is loaded onto the founders (and on the CN holders if the cap is calculated post-ESOP-expansion). Read the qualified-financing clause carefully: does the conversion happen before the ESOP expansion, or after? Founders who don’t fight for “pre-expansion” lose another 1 to 3 percent of the cap table.
Procedural compliance: MGT-14, Form CN and the post-issuance file
The drafting is half the job. The other half is the regulatory paperwork in the four weeks after the CN is signed and money is wired.
Board and shareholder approvals
The board passes a resolution under Section 179 of the Companies Act, 2013 approving the issuance of convertible notes on the terms agreed in the term sheet, authorising specific officers to execute the documentation, and convening a general meeting (extraordinary or annual, as applicable) to put the issuance to shareholders.
The general meeting passes a special resolution under Section 62(3) approving the issuance of convertible securities to identified persons on the terms set out in the explanatory statement. The explanatory statement should record: the rationale for the issuance, the names and details of the proposed allottees, the principal amount per investor, the conversion mechanics (cap, discount, qualified-financing trigger), the maturity, the interest rate, and any rights granted (information, anti-dilution).
What experienced practitioners know: do not skip the explanatory statement detail. A thin explanatory statement gives a future dissatisfied shareholder grounds to challenge the issuance under Section 241 of the Companies Act, 2013 on oppression-and-mismanagement grounds. The explanatory statement is the contemporaneous record of what the company told the shareholders.
Form MGT-14: the 30-day clock
Form MGT-14 is the ROC notification for board resolutions and special resolutions of certain categories. Section 62(3) special resolutions fall within the MGT-14 net.
The clock starts on the date the special resolution is passed at the general meeting. The filing must reach the ROC within 30 days, with the certified copy of the resolution and the explanatory statement annexed. Late filings attract additional fees on a graduated scale; very late filings (beyond 270 days) require a condonation application before the Regional Director.
The cleaner sequence is: special resolution at GM → MGT-14 filed within 7 to 10 days (not 30) → CN executed and money received → Form CN filed within 30 days of CN execution if a foreign investor is in. Bunching the filings against the 30-day deadline introduces avoidable risk.
Form CN for foreign investors and the AD-bank channel
Form CN is filed with the RBI through the company’s AD bank, within 30 days of issuance of the convertible note to the foreign investor. The form records: the investor’s identification, the amount and tenure of the CN, the conversion terms, and the sectoral classification of the company.
The AD bank verifies the FIRC for the inward remittance, the company’s DPIIT recognition, and the sectoral classification. The bank then transmits Form CN to the RBI. The KYC and FATCA documentation for the foreign investor moves through the AD bank channel.
On conversion, Form FC-GPR is filed within 30 days of the share allotment. The FC-GPR records the conversion event and the equity issued. The FEMA reporting chain (CN → FC-GPR) is therefore a two-stage process for every foreign-investor convertible note.
Internal records: register of CN holders, certificate stamping, evidence preservation
The company maintains a register of CN holders, the resolutions, the executed CN agreements, the stamped CN certificates, and the FIRCs and FC-GPRs (for foreign-investor cheques). The register is part of the statutory records under Section 88 of the Companies Act read with the Companies (Management and Administration) Rules, 2014.
Each CN certificate must be stamped under the applicable state stamp legislation. The CN agreement itself is also stamped at the time of execution. State-wise stamp rates are covered in the next section; the practical move is to e-stamp both the agreement and the certificate at the time of execution, not retrospectively. Retrospective stamping triggers penalties under the Indian Stamp Act, 1899, that can balloon over time.
Can a convertible note be transferred or assigned to a new investor? Under Indian practice, yes, with two conditions: the company’s prior written consent (which the CN agreement should require expressly), and compliance with FEMA pricing and reporting if a non-resident assignee is involved. The transfer is documented through a deed of assignment and recorded in the register of CN holders.
Stamp duty on convertible notes and CCPS: a state-by-state read
Stamp duty is a state subject, and the rates vary materially across India. The same convertible note can attract stamp duty of ₹100 in one state and ₹50,000 in another for an identical principal amount. The execution location matters.
Where the duty actually applies: agreement, certificate, and conversion
Three stamp duty touchpoints for a convertible note. First, the CN agreement itself, treated as a debenture or agreement under the relevant state’s stamp legislation. Second, the CN certificate issued to each subscriber, treated as a security instrument. Third, the share certificate issued on conversion, treated as a share certificate under Section 56 of the Companies Act, 2013 read with the Indian Stamp Act, 1899.
The agreement and the certificate are typically the dominant cost items at issuance. The conversion share certificate is usually a smaller amount, though states that levy stamp duty on share issuance can change the math.
State-by-state comparison
| State | Stamp duty on CN agreement | Stamp duty on CN certificate | Stamp duty on share certificate at conversion | Indicative reference |
|---|---|---|---|---|
| Maharashtra | 0.005% of consideration (subject to verification of current Schedule I to the Maharashtra Stamp Act) | Per debenture rate; verify against Article 27 | 0.1% of issue value (Article 17) | Maharashtra Stamp Act, Schedule I |
| Karnataka | ₹500 to ₹2,000 fixed (verify under Karnataka Stamp Act Schedule) | Verify under Article 22 | 0.1% of issue value | Karnataka Stamp Act, Schedule |
| Delhi (NCT) | ₹100 fixed, agreement category | Verify under Article 27 | 0.1% of issue value | Indian Stamp Act as adapted to Delhi |
| Tamil Nadu | Verify under Schedule I, Article 5 | Verify under Article 27 | 0.1% of issue value | Tamil Nadu Stamp Act |
| Telangana | Verify under Telangana Stamp Act, Schedule I | Verify under Article 27 | 0.1% of issue value | Telangana Stamp Act |
Fact-Checker note: each of the rates above should be verified against the current Schedule I of the relevant state’s stamp legislation. Stamp duty schedules are amended periodically through state finance acts; treat the above as indicative until the rate is confirmed against the live notification. The Maharashtra rate is the most punitive for high-value convertible notes; Karnataka and Delhi are materially cheaper. For more on how state-wise stamp duty interacts with commercial agreement drafting, the service agreement drafting guide maintains the most detailed cross-state matrix on the site.
Practical tips: execution location, e-stamping, and adjudication
Execution location determines the state whose stamp legislation applies. A convertible note signed and delivered in Mumbai is governed by Maharashtra stamp law, even if the company is registered in Bangalore. For high-value CNs, founders sometimes elect to execute in Karnataka or Delhi to capture the lower rate. This is permissible but the company should confirm the AOA and the SHA don’t require execution in the registered-office state.
E-stamping is the cleaner administrative move. Most states now accept e-stamping through SHCIL (Stock Holding Corporation of India Limited) and similar authorised agencies. Avoid franking-and-paper-stamp routes; they’re slower and create audit-trail headaches.
When in doubt about the applicable rate, file an adjudication application with the Collector of Stamps under Section 31 of the Indian Stamp Act, 1899 for an authoritative determination. The adjudication takes two to four weeks but locks in the rate and prevents downstream stamp-duty disputes at conversion.
CN vs SAFE vs iSAFE vs CCPS vs CCD: decision matrix
Five instruments. Different legal characters. Different commercial logic. Here’s the at-a-glance map, followed by the “choose X if” framework.
Five-instrument comparison
| Attribute | Convertible Note (CN) | SAFE (original Y Combinator) | iSAFE | Compulsorily Convertible Preference Shares (CCPS) | Compulsorily Convertible Debentures (CCD) |
|---|---|---|---|---|---|
| Legal character | Debt with conversion option | Contractual right to future equity | Equity (CCPS-wrapped) | Equity (preference shares) | Debt that must convert |
| Indian legal recognition | Yes (Deposit Rules, FEMA NDI) | No, not directly | Yes (as CCPS) | Yes (Section 55) | Yes (Section 71) |
| Minimum investment | ₹25 lakh per investor, single tranche | None (US default) | None (India practice ~₹10 to 25 lakh) | None | None |
| Issuance speed | 2 to 4 weeks | Not issuable in India | 2 to 4 weeks | 4 to 8 weeks (priced round) | 4 to 8 weeks |
| DPIIT recognition required | Yes | N/A | No (but recommended) | No | No |
| Valuation report | Not required at issuance | N/A | Not required at issuance | Required at issuance | Required at issuance |
| Conversion | Optional (holder may convert or be repaid) | Mandatory on trigger event | Mandatory on trigger event or date | Mandatory at fixed date or formula | Mandatory at fixed date or formula |
| Maturity / repayment | 10-year max, repayment possible | No maturity | No maturity | No maturity (conversion mandatory) | Up to 10 years, conversion mandatory |
| FEMA treatment (foreign investor) | Permitted under Rule 9 NDI | Not recognised | Permitted as CCPS | Permitted (equity instrument) | Permitted (equity instrument) |
| Insolvency classification (post-Sutanu Sinha) | Likely debt (because optional) | N/A | Likely equity | Equity | Depends on conversion mechanics |
| Typical use case | Pre-seed and seed bridge | US-style early-stage | Indian pre-seed | Seed and later priced rounds | Series A and beyond |
Choose a convertible note if
The CN is the right pick when the round is small and time-sensitive, when the cap table is clean and the founders want to defer the valuation conversation by 12 to 18 months, and when at least one investor is bringing a ₹25 lakh-or-larger single-tranche cheque. The CN is also the cleaner pick for cross-border deals where the foreign investor wants FEMA-recognised reporting. The optional-repayment feature is a small price to pay for the speed.
Choose iSAFE if
The iSAFE is the right pick when the lead investor is a 100X-style AIF or angel network that has standardised on the template, when the cheque sizes are below the CN ₹25 lakh single-tranche minimum, and when both parties are comfortable with equity-from-day-one classification. The iSAFE also wins when the founders want a perpetual instrument (no maturity, no repayment overhang). It is not the right pick when the issuer is an LLP (only companies can issue CCPS) or when the deal is cross-border in a sensitive sector.
Choose CCPS if
CCPS is the right pick at the seed or Series A round, when the company has enough operating data to set a valuation, and when the investor wants a fully priced equity instrument with mandatory conversion and a preferential dividend (however nominal). CCPS works well for Indian PE investors and for Series A leads coming from outside India. The downside is speed: CCPS is a priced equity round in everything but name, and the process takes four to eight weeks.
Choose CCD if
CCDs are the right pick for later-stage debt that the investor wants to convert into equity at a fixed event (typically an IPO trigger or a specific milestone). The CCD’s debt-leg sits on the balance sheet as a liability until conversion; the equity conversion is mandatory. CCDs are rare at pre-seed and seed; they show up more in Series B, growth, and pre-IPO deals. For pre-seed founders, CCDs are usually the wrong tool.
Conversion, disputes and the Sutanu Sinha effect on convertible instruments
The drafting choices in the clause-by-clause section above don’t exist in a vacuum. They’re shaped by what Indian courts have said about how convertible instruments should be classified when disputes hit. The two most important decisions are the Supreme Court’s 2023 ruling and the NCLAT’s 2024 follow-up.
The IFCI v. Sutanu Sinha framework
In November 2023, the Supreme Court decided M/s IFCI Limited v. Sutanu Sinha & Ors., 2023 INSC 1023, a corporate insolvency case where the question was whether compulsorily convertible debentures should be treated as financial debt or as equity under Section 5(8) of the Insolvency and Bankruptcy Code, 2016. The Court held that CCDs with automatic conversion provisions are in the nature of equity, not financial debt. The reasoning rested on the contract’s mechanics: where conversion is mandatory on a specified date or event, and where the parties’ conduct treated the instrument as equity in their dealings with third parties, the instrument is equity.
The drafting takeaway is direct. Whether an instrument is treated as debt or equity in insolvency depends on the contract terms. Automatic-conversion language with no holder option to be repaid points to equity. Optional-conversion language with a holder right to redemption points to debt. The court does not look at the label “convertible debenture” or “convertible note”; the court looks at the conversion mechanics.
What this means for a convertible note holder: because the standard CN includes a holder option to be repaid (at maturity, on default, or in certain other events), the CN is structurally closer to debt than to equity for insolvency classification. The Sutanu Sinha framework does not, on its own terms, address convertible notes as a distinct category. But the contract-mechanics test it announced applies across convertible instruments.
IREDA v. Waaree Energies and the contract-mechanics test
In December 2024, the NCLAT decided Indian Renewable Energy Development Agency Ltd. v. Waaree Energies Ltd., Comp. App. (AT) (Ins) No. 1380 of 2024, distinguishing Sutanu Sinha on the facts. The NCLAT held that the CCDs in question, which provided for both optional conversion and redemption, constituted financial debt under the IBC. The tribunal’s reasoning: the instrument’s redemption feature evidenced “time value of money” (the hallmark of financial debt), and the optional conversion (rather than automatic) signalled debt classification.
The two decisions together create a usable framework. Automatic-conversion-only instruments are equity. Optional-conversion-plus-redemption instruments are debt. Mixed instruments (where some conversion is automatic and some is at the holder’s option) are read on their dominant feature.
For convertible-note drafting, the implication is that the holder’s right to be repaid at maturity should be expressed clearly, not buried. If the drafter wants the CN to be treated as debt in a future dispute (which the lender usually does), the optional-repayment feature should be in the headline of the clause, not in a footnote. If the parties want the instrument treated as equity (which a startup founder negotiating its own classification might prefer), the conversion should be drafted as automatic on the qualifying event, with the optional-repayment feature available only in narrow circumstances.
Drafting implication for CN holders: the optional-repayment feature
Santosh Kumar v. ASK Trusteeship Services Pvt. Ltd., Comp. App. (AT) (Ins) No. 926 of 2024 (NCLAT Principal Bench, decided January 2024), and Shubham Corporation Pvt. Ltd. v. Mr. Kotoju Vasudeva Rao, Company Appeal (AT) (CH) (Insolvency) No. 163 of 2023 (NCLAT Chennai, decided 22 May 2024) reinforce the Sutanu Sinha framework’s contract-mechanics test in the NCLAT context. Optional-conversion-with-redemption-right is debt; automatic-conversion-only is equity. The CN’s structural debt-classification matters because it determines the holder’s standing in a CIRP under the IBC.
What experienced practitioners know is that the classification question matters most in two scenarios: when the company enters CIRP before the CN converts, and when there’s a dispute over whether the holder should be paid out of liquidation proceeds. A debt-classified CN puts the holder in the financial-creditor queue. An equity-classified CN puts the holder behind every financial creditor in the queue. Holders who don’t think about classification at drafting stage discover it the hard way in liquidation.
Common founder mistakes in convertible-note drafting
This is the section every founder should read twice and every junior drafter should screenshot. The most expensive mistakes in pre-seed CN drafting share a pattern: they look small at signing and turn structural at conversion.
Loose “qualified financing” definitions and the bridge-round trap
The most common drafting error is defining qualified financing as “the next equity financing of the Company” without a numerical floor or instrument specification. A bridge round of ₹50 lakh from existing CN holders then triggers conversion at the wrong price, often at a valuation closer to the cap than the post-traction Series A valuation the founders were holding out for.
The fix: define qualified financing as “an equity financing of at least ₹X crore from third-party investors not affiliated with the existing CN holders, evidenced by the issuance of Series A Preferred Stock or equivalent CCPS”. Three lines. Saves three rounds of post-conversion argument.
Stacking cap and discount instead of “better-of”
A surprising number of pre-seed CN drafts (often template-copied from older or US sources) imply that the holder gets both the cap discount and the discount-rate discount stacked. That’s a drafting failure, not a commercial term any senior investor would actually demand. The market convention is “better-of”: the holder applies whichever mechanism gives them the lower conversion price, not both.
The fix: write the conversion clause with explicit “better-of” language. “Conversion shall occur at the lower of (a) the Cap Conversion Price, calculated as [Valuation Cap] divided by [Fully Diluted Share Count at Issuance], and (b) the Discount Conversion Price, calculated as the Series A Per-Share Price multiplied by (1 minus the Discount Rate).” Two sentences. Removes ambiguity entirely.
Ignoring ESOP-pool expansion in the conversion calculation
Series A leads almost always require the ESOP pool to be expanded as part of the round (typically from 5 percent pre-round to 10 to 15 percent post-round, with the expansion loaded onto the pre-money cap table). The ESOP-pool expansion is one of the most dilutive moves in a Series A, and the question of whether it lands on the founders only or also on the CN holders depends on whether the conversion math is run before or after the expansion.
The fix: the qualified-financing clause should specify whether conversion happens “pre-ESOP-expansion” or “post-ESOP-expansion”. The founder-friendly answer is pre-expansion (the CN holder shares the dilution); the investor-friendly answer is post-expansion (the founders absorb the full expansion). Either is negotiable; not addressing it is the mistake.
Skipping DPIIT renewal: the cliff most founders don’t see
[SECOND-ORDER] DPIIT recognition needs to be maintained, not just obtained. The 10-year incorporation cap is a hard ceiling. If the CN is issued in year 8 with a 10-year tenure cap, and the company doesn’t convert before year 10, the company loses DPIIT recognition (because it crosses the incorporation cap) and the CN loses its Deposit Rules carve-out (because the carve-out requires DPIIT recognition at issue and through the life of the instrument).
The fix: the CN agreement should covenant that the company will either convert or repay before the DPIIT recognition expiry, and the term sheet should set a conversion target well within the recognition window. Founders who issue a CN late in their DPIIT window without thinking through the renewal cliff are setting up a regulatory failure that surfaces at exactly the worst time. The discipline is the same as it is for contract drafting careers for law students who learn early: the schedule of every covenant must match the lifecycle of every gate the covenant depends on.
Foreign-investor convertible notes: the FEMA layer
About a third of Indian pre-seed cheques today carry a foreign component, either directly from a foreign individual angel, indirectly through an offshore fund, or through an Indian AIF that pools NRI money. The FEMA overlay adds three procedural steps and two substantive concerns to the standard CN drafting.
Who can subscribe, and who can’t
Under Rule 9 of the FEMA NDI Rules, 2019, any person resident outside India may subscribe to an Indian-startup-issued convertible note, with two exclusions: citizens and entities of Pakistan and Bangladesh. The exclusion is not a sectoral rule; it’s a country-of-origin restriction that applies across the board.
NRIs (non-resident Indians, defined under FEMA differently from the Income Tax Act) can subscribe on the same terms as other foreign investors. Foreign portfolio investors (FPIs) typically don’t use CNs because the FPI regime under SEBI has different instrument-eligibility rules; they more often use equity or convertible debentures issued through the recognised stock exchange or OTC routes.
Sectoral caps interaction at the moment of conversion
This is the substantive concern that founders most often miss. The sectoral classification of the company (defence, telecom, broadcasting, multi-brand retail, etc.) determines whether foreign investment is permitted under the automatic route or requires prior government approval. The cap-and-route framework applies at the moment of equity issuance, which for a CN is the conversion event.
A startup operating in an approval-route sector that issues a CN to a foreign investor without first obtaining government approval is in a difficult spot at conversion. Either the conversion is delayed (which violates the CN agreement and exposes the company to default claims), or the conversion happens without approval (which triggers FEMA contravention proceedings).
The drafting fix is upfront: confirm the sectoral classification before issuing the CN to a foreign investor, secure government approval if the sector requires it (the approval can be sought at issuance for the eventual conversion), and document the approval status as a CP to conversion in the CN agreement. The FDI compliance guide for startups covers the broader sectoral-cap framework in detail.
Form CN, FC-GPR and the AD-bank chain of filings
The procedural chain is: CN issued → FIRC obtained → Form CN filed with RBI through AD bank within 30 days → CN converts to equity → share certificate issued → Form FC-GPR filed within 30 days of allotment. Each step has a deadline, and the cost of missing the deadline is FEMA compounding (the regulator’s penalty-and-cure procedure).
Why are most foreign investors hesitant to use CNs in India? Three reasons. First, the optional-repayment feature in a domestic CN is structurally less elegant than a SAFE for cap-table modelling. Second, the FEMA reporting chain adds compliance friction. Third, the sectoral-cap interaction at conversion is harder to navigate than an upfront CCPS issuance. The CN is workable but more cumbersome than the alternatives. For most foreign-investor pre-seed deals, the structure ends up as either a CN with very tight covenants or a priced CCPS round.
What changes next: future outlook for SAFE-style instruments in India
The CN and iSAFE framework is settled enough to draft against, but the regulatory environment is moving. Two changes are likely in the next two to four years; one is already reshaping the practitioner market.
ICAI accounting guidance and the path to direct SAFE recognition
[FUTURE] The Institute of Chartered Accountants of India has been working on accounting guidance for SAFE-style instruments since 2022. The current ambiguity (whether to classify iSAFE as preference share capital or as a separate “future equity” line on the balance sheet) creates friction at audit time. Early signals suggest ICAI will issue a clarificatory note within the next 24 to 36 months. Whether SEBI or the MCA will follow with direct statutory recognition of a SAFE-style instrument is a longer bet (likely 36 to 60 months), driven by industry advocacy from AIFs and founder bodies.
Standardised iSAFE templates from industry bodies
[FUTURE] NASSCOM, IVCA (Indian Venture and Alternate Capital Association), and the Startup India ecosystem partners are converging on standardised template terms for iSAFE and CN agreements. A market-default valuation cap range (₹4 to 12 crore at pre-seed) and discount range (15 to 25 percent) is already converging in practice. Expect a formal template release from one or more of these bodies in the next 12 to 18 months. The downstream effect: drafting will become more about negotiating around the standard template, less about building one from scratch.
Why CS firms with pre-seed practices are pulling premium fees post-angel-tax abolition
[SECOND-ORDER] The angel-tax abolition has shifted the bottleneck in pre-seed deal closing from tax-officer scrutiny to drafting and filing throughput. Company secretaries and corporate associates who can issue CNs, file MGT-14 and Form CN, and close pre-seed deals in under three weeks are pulling premium fees in 2025-26. CS and corporate law practices that specialise in DPIIT-recognised-startup work are seeing a meaningful skill premium open up over generalist competitors on equivalent matters. The premium is widening as deal volume holds and turn-around expectations tighten. Junior corporate lawyers who want to be on the right side of this trajectory should treat the CN/iSAFE/CCPS drafting stack as a core skill, not a side competency. Becoming a corporate lawyer in India starts with mastering this stack early in practice.
Frequently asked questions about convertible notes and SAFE agreements India
Q1. What is a convertible note in India?
A convertible note in India is a debt instrument issued by a DPIIT-recognised startup that converts into equity on a defined trigger event, with a minimum investment of ₹25 lakh per investor in a single tranche and a maximum tenure of 10 years from the date of issue. The instrument is defined under Rule 2(1)(c)(xvii) of the Companies (Acceptance of Deposits) Rules, 2014, and is treated as an exempted deposit.
Q2. What is a SAFE agreement and is it legal in India?
A SAFE (Simple Agreement for Future Equity) is a contractual right to receive equity in a future financing event, designed by Y Combinator in 2013 for US Delaware companies. The original SAFE is not directly recognised under Indian corporate, securities, or FEMA law. Indian founders use iSAFE notes (a CCPS-structured equivalent) instead.
Q3. What is an iSAFE note?
The iSAFE is the Indian-law adaptation of the SAFE, structured as compulsorily convertible preference shares (CCPS) issued under Sections 42, 55 and 62 of the Companies Act, 2013. It was published by 100X.VC in July 2019 and is now the de facto template for Indian pre-seed deals between Indian companies and Indian or resident investors.
Q4. Who can issue a convertible note in India?
Only a DPIIT-recognised startup, organised as a private limited company, can issue a convertible note under the Deposit Rules carve-out. Partnership firms and LLPs cannot. The DPIIT recognition must be valid at the date of issue and maintained through the life of the instrument until conversion or repayment.
Q5. Is DPIIT recognition mandatory to issue a convertible note?
Yes. The convertible-note carve-out under Rule 2(1)(c)(xvii) of the Deposit Rules is available only to a startup recognised by the Department for Promotion of Industry and Internal Trade. Without DPIIT recognition, money received in the same form would be treated as a regulated deposit under the Companies Act, with all the public-deposit compliance obligations that classification carries.
Q6. What is the minimum investment for a convertible note in India?
The minimum is ₹25 lakh per investor in a single tranche. The threshold is per-investor, not aggregate, so a CN raise from three investors must have each investor putting in at least ₹25 lakh in a single tranche. Sub-threshold cheques must be pooled through a syndicate or routed through a different instrument.
Q7. What is the maximum tenure of a convertible note in India?
The maximum tenure is 10 years from the date of issue. The Companies (Acceptance of Deposits) Rules, 2014, were amended to extend the tenure from the original 5 years, and the FEMA Non-Debt Instruments Rules, 2019, were aligned in 2023. Commercial maturities are typically 24 to 36 months; the 10-year ceiling is the regulatory outer limit.
Q8. Can a convertible note be issued to foreign investors?
Yes, under Rule 9 of the FEMA NDI Rules, 2019, with two exclusions: citizens and entities of Pakistan and Bangladesh are not permitted to subscribe. The issuance triggers reporting through Form CN to the RBI via the AD bank within 30 days of issue, and Form FC-GPR within 30 days of conversion.
Q9. Is a valuation report required for issuing convertible notes?
No. One of the primary advantages of a convertible note is that the company does not need to obtain a registered-valuer report at issuance, because no equity shares are issued on day one. The valuation question is deferred to the conversion event, when the qualifying financing round’s per-share price (or the valuation cap) governs the conversion price.
Q10. What is a valuation cap and how is it different from a discount rate?
A valuation cap is a ceiling on the pre-money valuation at which the convertible note converts. A discount rate is a percentage reduction to the qualifying financing round’s per-share price. Most Indian CN agreements include both, with a “better-of” mechanism: the holder converts at whichever yields more shares (the lower conversion price).
Q11. Does the convertible note carry interest?
Most Indian pre-seed convertible notes carry simple interest at 5 to 8 percent per annum, accrued but not paid in cash during the term. The accrued interest adds to the principal at conversion, increasing the share count the holder receives. Some founder-friendly notes are issued at zero interest, particularly when the cap is tight and the relationship is strategic.
Q12. What is the stamp duty on a convertible note in India?
Stamp duty is a state subject and varies materially. Maharashtra applies a higher percentage rate (typically 0.005 percent on the consideration for the agreement); Karnataka and Delhi apply lower fixed amounts. The CN agreement, the CN certificate, and the share certificate issued on conversion are each separately stamped under the applicable state legislation.
Q13. Has angel tax under Section 56(2)(viib) been abolished?
Yes. The Finance Act 2024 made Section 56(2)(viib) inapplicable for any consideration received on or after 1 April 2025. The general angel tax is gone. What remains is Section 56(2)(x), which can apply at the conversion event if the equity allotted is materially below fair value in the holder’s hands.
Q14. Convertible note vs SAFE: which is better for an Indian pre-seed startup?
For most Indian pre-seed founders, the convertible note (or its iSAFE equivalent for sub-₹25 lakh cheques) is the better pick over the original Y Combinator SAFE, because the SAFE is not directly recognised under Indian law. The iSAFE works for domestic deals where the lead investor uses the 100X template; the CN works for both domestic and cross-border deals with a ₹25 lakh single-tranche minimum.
Q15. What is the difference between a convertible note and CCDs/CCPS?
A convertible note has an optional-repayment feature (the holder may convert or be repaid); a CCD (compulsorily convertible debenture) must convert and cannot be repaid in cash. CCPS (compulsorily convertible preference shares) is a priced equity instrument that converts on a defined date or formula. The CN is debt-with-option; CCDs and CCPS are debt-must-convert and equity-must-convert respectively.
Q16. What happens if the convertible note doesn’t convert before maturity?
Three outcomes are possible, depending on the agreement: automatic conversion at a default price (typically the valuation cap), holder option to convert or be repaid, or extension of maturity. Most Indian CN agreements use the second option. If the holder elects repayment and the company doesn’t have cash, the CN becomes a non-performing instrument, and the holder can invoke remedies including potential insolvency proceedings.
Q17. What’s the total cost of issuing a convertible note in India?
Legal fees for drafting and filing typically run ₹50,000 to ₹2 lakh for a clean single-investor CN, depending on the firm. Stamp duty varies by state (₹100 in Delhi to several thousand rupees in Maharashtra for the agreement and certificate). MGT-14 government fees are nominal. For foreign-investor CNs, add AD-bank charges and Form CN filing costs. All-in, a domestic-investor pre-seed CN typically closes for ₹1 to 3 lakh in transaction costs; a foreign-investor CN runs ₹2 to 5 lakh.
References
Case Law
- Indian Renewable Energy Development Agency Ltd. v. Waaree Energies Ltd., Comp. App. (AT) (Ins) No. 1380 of 2024. NCLAT Principal Bench, decided 6 December 2024.
- M/s IFCI Ltd. v. Sutanu Sinha & Ors., 2023 INSC 1023. Supreme Court of India, decided 9 November 2023. Civil Appeal No. 4929 of 2023.
- Santosh Kumar v. ASK Trusteeship Services Pvt. Ltd. & Anr., Comp. App. (AT) (Ins) No. 926 of 2024. NCLAT Principal Bench, New Delhi, decided January 2024. (Indian Kanoon URL not yet indexed; case is on appeal before the Supreme Court in Civil Appeal No. 930 of 2024.)
- Shubham Corporation Pvt. Ltd. v. Mr. Kotoju Vasudeva Rao (IRP of Navayuga Infotech Pvt. Ltd.) & Anr., Company Appeal (AT) (CH) (Insolvency) No. 163 of 2023. NCLAT Chennai, decided 22 May 2024.
Statutes
- Indian Stamp Act, 1899. Section 31 cited, read with state stamp legislation: Maharashtra Stamp Act, Karnataka Stamp Act, Tamil Nadu Stamp Act, Telangana Stamp Act, and the Indian Stamp Act as adapted to Delhi.
- Income Tax Act, 1961. Sections cited: 47(xb), 56(2)(viib) (abolished w.e.f. 1 April 2025 by Finance Act 2024), 56(2)(x).
- SEBI (Alternative Investment Funds) Regulations, 2012. Category I AIF investment framework.
- Companies Act, 2013. Sections cited: 2(31), 42, 55, 56, 62(3), 71 (CCDs), 88, 179, 241.
- Companies (Acceptance of Deposits) Rules, 2014. Rule 2(1)(c)(xvii): the convertible-note carve-out.
- Companies (Share Capital and Debentures) Rules, 2014. Rule 9: issuance of CCPS.
- Companies (Management and Administration) Rules, 2014. Register of holders and Form MGT-14 filing format.
- Insolvency and Bankruptcy Code, 2016. Section 5(8): financial-debt definition.
- Foreign Exchange Management (Non-Debt Instruments) Rules, 2019. Rule 9: foreign-investor convertible notes.
- Finance Act, 2024. Angel-tax abolition provision (rendered Section 56(2)(viib) of the Income Tax Act, 1961, inapplicable w.e.f. 1 April 2025).
Regulatory and industry sources
- DPIIT Startup India recognition portal: https://www.startupindia.gov.in/
- RBI Master Direction on FDI (Form CN, Form FC-GPR): https://www.rbi.org.in/
- 100X.VC iSAFE template (primary source for iSAFE structure): https://www.100x.vc/isafe
Legal disclaimer
This article is for informational and educational purposes only and does not constitute legal advice. Convertible notes, iSAFE agreements, CCPS and related instruments involve specific regulatory, tax and commercial trade-offs that depend on the particular facts of each transaction. For specific guidance on drafting or issuing any of these instruments, consult a qualified Indian legal and tax professional.
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