"We'll do a SAFE or convertible note": What the Companies Act and FEMA actually require in India

A US-based angel offers your Bangalore startup ₹2 crore on a convertible note — "same doc I use for Delaware companies, converts at your next round, 20% discount." The founder signs, the money lands, and everyone assumes the paperwork is a formality to be cleaned up at Series A. Eighteen months later, during due diligence, the lead investor's counsel flags it: the instrument was never a valid convertible note under Indian law, the inbound remittance was reported under the wrong FEMA route, and the company is now sitting on a compounding application with the Reserve Bank of India. What looked like the fastest, cheapest way to raise turned into the single biggest red flag in the data room.

This is one of the most common — and most expensive — mistakes Indian founders make when they take foreign money. The core misunderstanding is simple: a US-style SAFE or convertible note does not exist as a recognised instrument under the Companies Act 2013, and the "Convertible Note" that FEMA does recognise is a narrow, specific thing that most early-stage companies cannot legally issue. Here is what the law actually requires.

What the law actually requires

There are only two convertible instruments Indian law recognises for foreign investment

Under the Foreign Exchange Management (Non-Debt Instruments) Rules, 2019 ("NDI Rules"), a non-resident can subscribe to exactly these convertible instruments in an Indian company: Compulsorily Convertible Preference Shares (CCPS) and Compulsorily Convertible Debentures (CCDs). The word that matters is compulsorily. The instrument must convert into equity — there can be no option for the investor to demand repayment in cash instead. An instrument that lets the holder choose money back is a debt instrument, and foreign debt is governed by the External Commercial Borrowing (ECB) framework, not the equity route. A classic US convertible note — which is legally a loan that may convert — fails this test immediately.

The actual "Convertible Note" is a startup-only, ₹25 lakh-floor instrument

FEMA does define a genuine Convertible Note — but it is a special carve-out, not a general tool. Under Rule 2 read with Schedule I of the NDI Rules 2019, a Convertible Note can only be issued by a company that qualifies as a "startup" under the DPIIT definition (the G.S.R. 127(E) notification framework). The conditions are strict:

• The startup must receive at least ₹25 lakh in a single tranche from the non-resident.
• The note must convert into equity within a maximum of 10 years from the date of issue (extended from the earlier 5-year window).
• Conversion is linked to a valuation event or the note's terms; the instrument sits somewhere between debt and equity until then.

If your company is not a DPIIT-recognised startup (see also: what DPIIT recognition actually provides), or the cheque is below ₹25 lakh, you simply cannot use the Convertible Note route. Your only compliant path for that foreign money is CCPS or CCDs — which are priced, allotted, and reported like equity from day one.

The pricing floor is not optional

Every foreign-invested convertible instrument must respect the pricing guidelines in Rule 21 of the NDI Rules. Shares or convertibles issued to a non-resident cannot be priced below the fair value worked out by a SEBI-registered Category I Merchant Banker or a Chartered Accountant using an internationally accepted methodology (typically Discounted Cash Flow). A "we'll figure out the price at conversion" note offends this: at the point of issue of CCPS/CCDs, the conversion formula must ensure the eventual price is not below fair value at the time the instrument was issued. This is exactly where retrofitted SAFEs collapse.

Companies Act allotment rules apply in parallel

FEMA governs the cross-border leg; the Companies Act 2013 governs the issue itself. CCPS and CCDs issued to any investor — resident or not — must go through Section 42 (private placement) and the associated Rule 14 of the Companies (Prospectus and Allotment of Securities) Rules, 2014. That means a PAS-4 private placement offer letter, a special resolution, money received only into a separate bank account, allotment within 60 days of receiving the application money, and a PAS-3 return of allotment filed within 15 days of allotment. Skip the separate bank account or blow the 60-day window, and the money must be refunded within 15 days — after which it is treated as a deposit and penalties bite.

Practical implications — what actually happens when this is ignored

The FEMA reporting failure is the one that hurts. Any foreign investment into equity or convertible instruments must be reported to the RBI through Form FC-GPR filed on the FIRMS portal within 30 days of allotment. A convertible note has its own reporting (Form CN), to be filed within 30 days of issue, with conversion later reported separately. Miss the window and you owe a Late Submission Fee (LSF), calculated under the RBI's formula — broadly ₹7,500 plus a percentage of the amount involved per year of delay, which scales quickly on a crore-plus round. Serious or structural breaches (wrong instrument, wrong route) cannot be fixed by LSF at all and must go through compounding under Section 15 of FEMA, where penalties can run into lakhs and the process takes months.

MCA21 v3 makes the Companies Act side visible. With the V3 portal migration now complete and the legacy V2 portal decommissioned, PAS-3 allotment data auto-populates a company's master data and share capital records. A missing or late PAS-3 for a foreign allotment is now far easier for the ROC to flag, and it surfaces instantly during any subsequent filing or diligence.

The convertible-note-as-deposit trap. If a non-startup company takes money on a "note" that is really a loan and never validly converts it, it risks being treated as having accepted a deposit under Section 73 of the Companies Act and the Companies (Acceptance of Deposits) Rules. That drags in DPT-3 reporting obligations — and note that for FY 2025-26 the MCA has extended the DPT-3 due date to 31 July 2026 via General Circular No. 02/2026. A misclassified note can quietly become a reportable, penalty-bearing deposit.

Diligence discount or dead deal. The commercial cost is often larger than the penalty. A cap table with an unreported or mis-structured foreign instrument forces the incoming investor to either haircut the valuation, escrow part of the round pending regulatory clean-up, or walk.

Step-by-step: what to do

• Confirm your DPIIT startup status first. Log in to the Startup India portal and verify you hold a valid DPIIT recognition certificate. Only then is the Convertible Note route even available to you. No recognition, no note — plan for CCPS/CCDs.
• Choose the right instrument before the money moves. DPIIT startup + ≥₹25 lakh single tranche + comfort with a debt-flavoured instrument → Convertible Note. Everyone else → CCPS (most common for equity-style rounds) or CCDs.
• Get a valuation report. Engage a SEBI-registered Merchant Banker or CA for a DCF fair valuation before issue. This sets your floor price and protects the conversion formula.
• Run the Section 42 private placement. Pass the special resolution, issue PAS-4, collect money into a dedicated bank account, and allot within 60 days.
• File PAS-3 within 15 days of allotment on MCA21 v3.
• Report to the RBI. File Form CN within 30 days of issuing a convertible note, or Form FC-GPR within 30 days of allotting CCPS/CCDs, on the FIRMS portal. Keep the FIRMS acknowledgement — diligence teams ask for it by name.
• Track conversion and report it. When the note or convertible converts, file the conversion intimation (and FC-GPR on conversion of a CN) within the prescribed window.
• If you already messed it up, don't compound the delay. Compute the LSF, or prepare a compounding application, and file voluntarily — self-reporting is treated far more leniently than a breach the RBI discovers.

Closing

Foreign money is not the place to save on paperwork. The instrument, the valuation, the Section 42 process, and the FIRMS reporting all have to line up before the cheque clears — because the RBI and the ROC both look back, and your next investor will too. For a compliance audit of your company, visit pvtltd.co. If you are closing an equity seed round at the same time, our guide to SHA, SPA, and CCPS documentation under the Companies Act 2013 covers what else needs to be in place before money lands.

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See Also

• MCA just extended your compliance deadline to 31 August: what the CCFS-2026 relief scheme actually covers
• "We need a merchant banker valuation or the angel tax will kill us": What the Companies Act and Income Tax Act actually require now
• Closing a Seed Round Without Proper Paperwork: What Companies Act 2013 and FEMA Actually Require

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