Convertible bonds are debt securities that have the option to be converted into shares of the issuer’s common stock. Convertible bonds, also known as convertible notes, were initially issued in the United States in the nineteenth century to raise funds for the expansion of the railway system.
Who is authorized to issue convertible notes?
A convertible note is an instrument issued by a startup company evidencing the receipt of money initially as debt, which is repayable at the holder’s option, or convertible into such number of equity shares of the startup company, within a period of not more than five 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, within a period not exceeding five years from the date of issue of the convertible note.
Convertible Notes can be utilized as an investment option for Indian startups wishing to raise capital from sources outside than the company’s directors, family, or shareholders.
A Convertible Note is a new credit instrument that can be used to get credit from a foreign national or foreign entity. FEMA Regulations specify the conditions and requirements for obtaining a Convertible Note.
Requirements for issue of Convertible Note (CN):
- Only a ‘Startup Company’ recognized by the Department of Industrial Policy and Promotion, Ministry of Commerce and Industry, can issue a Convertible Note (DIPP)
- A convertible note is an instrument that documents the receipt of money as a debt that is repayable at the holder’s discretion.
- A single tranche investment in a Convertible Note must be at least Rs.25 lakhs.
- The convertible note can be repaid or converted into a certain number of equity shares in the starting company.
- Repayment or conversion must take place within five years of the convertible note’s issuance date.
- The Convertible Note’s terms and conditions must be agreed upon and stated in the instrument.
What is a Startup Company?
âStartup companyâ means a private company incorporated under the Companies Act, 2013 and recognized as such by the Department of Industrial Policy and Promotion, Ministry of Commerce and Industry, Government of India, in accordance with notification number G.S.R. 180(E) dated February 17, 2016 and complies with its conditions;
Only after receiving a Certificate of Registration from Start-up India Hub can a firm be recognized as a âStart-upâ under this scheme.
Reporting to RBI
Within 30 days of issuing Convertible Notes to a person residing outside of India, the Indian startup firm must report such inflows to the Authorised Dealer bank in Form CN.
Conditions and Procedure for Issue of Convertible Note (CN)
A person residing outside of India (other than a Pakistani or Bangladeshi citizen or a company registered or incorporated in Pakistan or Bangladesh) is eligible to invest up to 25 lakh rupees in a single tranche in a Convertible Note issued by an Indian startup firm.
- If a new firm operates in a sector that requires government clearance for foreign investment, it can only issue Convertible Note if such approval is granted.
- In accordance with FEMA laws, regulations, and guidelines, a Convertible Note issued by an Indian startup firm can be convertible into equity shares of the company.
- A person residing outside of India can purchase or sell convertible notes from or to a person residing in or outside of India, as long as the transaction follows the entry routes and pricing requirements.
- Both repatriation and non-repatriation Convertible Notes are available. However, in compliance with RBI instructions/guidelines, an NRI or an OCI may acquire convertible notes on a non-repatriation basis.
- A person residing outside of India can obtain the payment consideration by –
Provided that the escrow account set up for this purpose is closed either immediately after the requirements are met or within six months, whichever comes first. An escrow account of this type may not be kept open for more than six months.
Convertible Note (CN) Agrement
The Company issuing Convertible Notes and the Investor must sign an agreement outlining the terms and conditions of the Convertible Notes.
What is a convertible bond’s holder?
A vanilla convertible bond gives investors the option of holding the bond until it matures or converting it to stock. If the stock price has fallen after the bond was issued, the investor can keep the bond until it matures and receive the face value. If the stock price rises sufficiently, the investor can convert the bond to stock and choose whether to hold or sell the stock. When the gain from the stock sale surpasses the face value of the bond plus the total amount of remaining interest payments, an investor should convert the bond to stock.
Why do businesses offer convertible bonds?
- Convertible bonds are corporate bonds that can be exchanged for the issuing company’s common stock.
- Convertible bonds are issued by companies to cut debt coupon rates and defer dilution.
- The conversion ratio of a bond decides how many shares an investor will receive in exchange for it.
- Companies can force bond conversion if the stock price is higher than the bond’s redemption price.
Is it possible for a private firm to issue convertible notes?
Only recognized start-ups are permitted to issue convertible notes. “Start-up firm” refers to a private company registered under the Companies Act, 2013 or the Companies Act, 1956, and recognized as such by notification number G.S.R. Only NRIs are eligible to receive convertible notes.
Are convertible notes possible for startups?
It is the simplest and most straightforward method of raising funds. Convertible Notes (CN) can only be issued by Startup India-registered private limited companies. In India, convertible notes are similar to iSAFE in the United States.
What exactly are convertible problems?
What exactly is a convertible problem? It’s a type of corporate bond that can be exchanged for shares of the firm that issued it. Although ‘convertibles’ are a popular asset type, retail consumers should seek financial advice before investing in them.
Why are investors drawn to convertible bonds?
Convertible bonds are appealing because the fixed income component (i.e., the investment value) of the convertible bond functions as a support level below which the convertible bond will not fall as the stock price declines.
What is the definition of a serial bond issue?
In finance, a serial bond is a bond whose maturity dates are spread out over a number of years such that a specific number of bonds mature each year. The serial-bond debt-repayment method is commonly utilized by governments and municipalities in many countries, and it has largely replaced the sinking-fund approach in public issues. Serial bonds have a wide range of maturities, allowing the issuer to sell to a broader range of investors. Serial bonds, in comparison to sinking-fund bonds, have a shorter average maturity.
Can ordinary people acquire convertible bonds?
Convertible bonds can be purchased in a variety of ways. Individual bonds can be purchased through a brokerage that has a bond desk and a convertibles specialist. Convertibles, on the other hand, aren’t widely available, thus many brokerages don’t provide direct investments in them.
If you wish to invest directly, do your homework first. Before making any judgments, go over the bond contract, examine the credit ratings, and learn everything you can about the company.
Many investing businesses offer mutual funds and exchange-traded funds (ETFs) that invest in convertible bonds as an alternative. Almost any investor can find something that suits them. However, keep in mind that these funds are often connected with stock market performance and may look similar to equities funds, albeit with a larger dividend yield.