Convertible Notes for Indian Startups: How They Work

What a convertible note actually is (and what it isn’t)

Here’s the thing about a convertible note: it starts life as a loan and ends life as shares. The startup borrows money today. Instead of paying it back in cash, the company (in almost every real-world case) settles the debt by issuing equity at a future priced round. The note is the bridge between “we need money now” and “we’ll agree on a valuation later.”

Debt now, equity later

At issue, the investor hands over money and the startup records it as borrowing, not as share capital. No shares move. No shareholding percentage is fixed. What the investor holds is a contractual right to convert that debt into equity when a defined event occurs, at a price worked out using the terms baked into the note. Until that moment, the investor is a creditor, not a shareholder, which matters for voting, for board rights, and for what happens if the company folds.

So why borrow money you plan never to repay in cash? Because the conversion is the point. The note lets both sides postpone the single hardest negotiation in early-stage fundraising: what is this company worth today?

Why founders reach for it: deferring the valuation question

Valuing a company with twelve months of history and no comparable transactions is mostly fiction. A convertible note sidesteps that. Rather than argue about whether the startup is worth Rs 8 crore or Rs 15 crore right now, the parties agree to let the next institutional investor (a VC fund doing real diligence) set the price, and then convert the note relative to that price. The early investor gets compensated for going first through the cap and the discount. Everyone avoids a valuation they’d have to invent.

How it differs from a priced equity round

A priced round fixes everything now: valuation, share price, percentage ownership, board seats. A convertible note fixes almost none of that, deliberately. The only hard numbers in the note are the cap, the discount, the interest rate, and the maturity date. Ownership stays undetermined until conversion.

That’s the trade. You buy speed and deferral, and you pay for it with uncertainty about the final cap table. The founder in the opening story learned that the hard way: the note felt cheap at signing precisely because its real cost was invisible until the Series A made it concrete.

How a convertible note works, step by step

What does the lifecycle actually look like, from cheque to cap table? Three phases: the money goes in, a trigger fires, and the note resolves into either shares or (rarely) a repayment.

Money in: issue and the note terms

The startup and the investor agree the commercial terms, sign the convertible note agreement, and the investor transfers the funds. The company books the amount as a borrowing on its balance sheet. In India, this is the moment the regulatory clock starts: if a foreign investor is involved, the company must file Form CN within 30 days (more on that below), and the note must be structured so it converts or is repaid within 10 years.

At this stage the note is dormant. It accrues interest if the terms say so, but nothing converts. The investor waits for a trigger.

The trigger: qualified financing, maturity, or a liquidity event

A convertible note doesn’t convert on a calendar date. It converts when a defined event happens. Three triggers show up in almost every note.

The primary trigger is a qualified financing: the startup’s next priced equity round above a threshold size (say, the next round that raises Rs 5 crore or more). When that round closes, the note converts into the same class of shares the new investors are buying, at a price discounted from the round price. This is what the note is built to do.

The second trigger is maturity: the outer date by which the note must resolve. If no qualified financing has happened by then, the investor typically gets a choice (convert at a pre-agreed valuation, extend, or demand repayment). In India, this date can’t be more than 10 years out.

The third is a liquidity event: an acquisition or sale before any priced round. Here the note usually converts just before the sale or pays out a multiple of the invested amount, depending on what the parties negotiated.

Conversion or repayment: what actually happens

Now, here’s where it gets interesting. At a qualified financing, the note’s principal (plus accrued interest, if it converts too) is divided by the conversion price to produce a share count. The conversion price is the lower of the cap-implied price and the discounted round price, which is the whole game and the subject of the next two sections.

Repayment in cash is the rare path. Most notes are written expecting conversion, and most founders can’t repay a maturing note in cash anyway (the money’s been spent on growth). But the repayment right is real, and a maturity date with no funding round in sight is exactly the scenario where it bites. Worth flagging: a note is still legally debt until it converts, so an investor who insists on repayment at maturity is within their rights.

The four numbers that decide everything

Strip away the legal language and a convertible note comes down to four levers. Get these right and the instrument is founder-friendly. Get them wrong and you’ll donate equity you didn’t mean to.

Valuation cap: the ceiling on conversion price

The valuation cap is the maximum company valuation at which the investor’s money converts, regardless of how high the next round prices the company. It exists to reward the early investor for betting before anyone else would.

Think of it this way. Your investor put in money when the company was unproven. If the next round values you at Rs 30 crore but the note carried a Rs 6 crore cap, the investor converts as if the company were worth Rs 6 crore, not Rs 30 crore. Their effective price per share is far lower than the new investors’, so the same rupees buy more shares. The cap protects the early investor from being diluted into irrelevance by a big up-round. It also, as our opening founder discovered, transfers that benefit straight from the founder’s ownership.

Discount rate: the early-investor reward

The discount is simpler. It’s a percentage (commonly 10% to 25%) knocked off the price the new investors pay, applied to the note holder’s conversion. A 20% discount means the note converts at 80% of the round price.

The discount is a reward for time and risk: the early investor took the bet months before the priced round, so they convert cheaper than the people who showed up later with more information. Some notes carry only a discount. Some carry only a cap. Many carry both, and that’s where the math gets pointed.

Interest: it accrues, it rarely pays out in cash

Because a convertible note is legally a loan, it can carry interest, often in the 6% to 12% range. But this interest almost never gets paid in cash. Instead, it accrues and is added to the principal at conversion, so the investor converts on a slightly larger amount.

On a Rs 50 lakh note at 8% for 18 months, that’s roughly Rs 6 lakh of accrued interest folded into the conversion, buying the investor a few more shares. Not enormous, but real, and founders routinely forget it’s there until the conversion spreadsheet reminds them.

Maturity date: the 10-year outer limit in India

The maturity date is the deadline by which the note must convert or be repaid. Commercially, founders push it long enough to comfortably reach the next round (18 to 36 months is typical). Legally, in India, it cannot exceed 10 years from the date of issue. Miss that statutory boundary and the instrument stops being a valid convertible note, with consequences we’ll get to in the legal section.

So which of these four can you negotiate? All of them, except the 10-year ceiling, which is Indian law and non-negotiable. The cap is usually the hardest fought, because it moves the most equity.

The conversion math, worked out

Numbers make this concrete in a way definitions never will. The examples below are illustrative, built on round figures to show the mechanics, not real transactions. But the logic is exactly how a real conversion runs.

Take a base case. An angel invests Rs 50 lakh on a convertible note. Eighteen months later the startup raises a Series A that prices shares at Rs 100 per share (a “qualified financing”). What does the angel get?

Discount only

Suppose the note has a 20% discount and no cap. The angel converts at 80% of the round price: Rs 100 minus 20% equals Rs 80 per share.

Rs 50,00,000 divided by Rs 80 = 62,500 shares. A new Series A investor putting in the same Rs 50 lakh at Rs 100 gets only 50,000 shares. The discount earned the angel 12,500 extra shares for being early. Clean and modest.

Cap only

Now drop the discount and add a valuation cap of Rs 6 crore, with the Series A pricing the company at a Rs 30 crore pre-money valuation (the Rs 100 share price reflects that Rs 30 crore). The cap says the angel converts as if the company were worth Rs 6 crore, not Rs 30 crore.

The cap-implied price is the round price scaled down by the ratio of cap to round valuation: Rs 100 multiplied by (6 ÷ 30) = Rs 20 per share. Rs 50,00,000 divided by Rs 20 = 2,50,000 shares. That’s five times what the same money buys at the round price. When the next round massively outruns the cap, the cap, not the discount, does the heavy lifting, and the founder feels it.

Cap vs discount: the investor takes whichever is better

Most real notes carry both a cap and a discount, and the conversion uses whichever produces the lower price (more shares) for the investor. The investor doesn’t add them. They take the better of the two.

Using the numbers above: the discount route gives Rs 80 per share; the cap route gives Rs 20 per share. The investor converts at Rs 20. The cap wins because the round (Rs 30 crore) blew far past the cap (Rs 6 crore). Flip it: if the Series A had priced the company at only Rs 7 crore, the cap-implied price (Rs 100 × 7÷7 ≈ Rs 93) would be worse for the investor than the 20% discount (Rs 80), so the discount would govern. The cap matters most in a strong up-round; the discount matters most in a flat or soft one.

The MFN clause: inheriting a later note’s better terms

One more term shows up in note-heavy rounds: the most-favoured-nation (MFN) clause. If a startup issues several convertible notes over time and a later note carries better terms (a lower cap, a bigger discount), an MFN clause lets the earlier investor adopt those better terms.

The practical effect? You can’t quietly give a new note a sweeter cap to close a deal, because your existing MFN holders ratchet up to match. We’d recommend founders track every outstanding note’s cap, discount and MFN status on a single sheet before issuing the next one, because the interaction is exactly the kind of thing that ambushes a cap table at Series A.

The legal framework in India: FEMA, Companies Act, DPIIT

A convertible note isn’t just a contract in India. It’s a defined statutory instrument, and only certain companies can issue it. Two regimes govern it: the Companies Act (the deposit rules) for the instrument itself, and FEMA (the Non-Debt Instruments Rules) when a foreign investor is on the other side.

The Companies Act side: the deposit exemption

The FEMA side: convertible notes as a foreign-investment route

Who can issue: DPIIT-recognised startups only

Here’s the gate that catches founders off guard. Only a startup recognised by the Department for Promotion of Industry and Internal Trade (DPIIT) can issue convertible notes. An ordinary private limited company that hasn’t obtained DPIIT recognition simply isn’t eligible, no matter how early-stage it is.

So before a single rupee comes in on a note, the company needs to be DPIIT-recognised under the startup definition. The recognition is free and online, but it’s a precondition, not a formality you can backfill later. Issue a “convertible note” without it and you don’t have a convertible note. You have an unauthorised deposit or a mispriced security.

Issuing to a foreign investor: Form CN, sectors and pricing

Form CN within 30 days on the FIRMS portal

When an Indian startup issues a convertible note to a non-resident, it must report the issue in Form CN within 30 days of issuance, filed through the Reserve Bank’s FIRMS portal under the Single Master Form framework. The same 30-day clock applies when a convertible note is transferred between a resident and a non-resident.

That deadline is not cosmetic. Late or missed reporting is a FEMA contravention that can require compounding (a paid regularisation) before the company can cleanly proceed to conversion or a later round. The catch? The clock starts at issue, not at conversion, so a founder who treats the note as “not real until it converts” has already missed the filing.

Sector caps and the land-border condition

A foreign investor can buy convertible notes only where foreign investment in that sector is otherwise permitted. If the startup operates in a sector where 100% FDI is allowed under the automatic route, the note can be issued without prior approval. If the sector sits under the government (approval) route or has a cap, the convertible note investment needs the same prior government approval that a direct equity investment would.

There’s a country overlay too. The FEMA Rules specifically bar a citizen of, or entity incorporated in, Pakistan or Bangladesh from buying convertible notes in an Indian startup. And under the land-border rule introduced by Press Note 3 of 2020, an investor from a country sharing a land border with India can invest only with prior government approval. For a startup taking money from a cross-border angel, checking the investor’s nationality and the sector route is step zero, not an afterthought.

Pricing at conversion: the fair-value floor

When the note finally converts into equity for a non-resident, the conversion has to respect FEMA’s pricing guidelines. The shares can’t be issued to the foreign investor below the fair value worked out under an internationally accepted methodology at the time of conversion. In practice this rarely conflicts with the cap and discount, because those usually price the investor above the regulatory floor, but the floor is a hard constraint, and a valuation certificate is the document that proves you cleared it.

Convertible note vs CCPS vs CCD vs SAFE

Founders often ask why they’d use a convertible note rather than the other instruments floating around Indian term sheets. The honest answer: it depends on whether you want to defer valuation, and whether your investor is domestic or foreign. Here’s the comparison a corporate lawyer keeps on one page.

When each one is the right call

What founders get wrong (and how to negotiate)

The instrument is only as good as the terms you sign. These are the mistakes we see most often, and the ones that quietly cost founders the most equity.

Stacking too many notes with different caps

A founder closes one note, then another, then a third, each at a slightly different cap to get each angel across the line. Come the priced round, all of them convert at once, each at its own (low) cap, and the combined dilution is far larger than any single note suggested. This is where most founders go wrong. Model the aggregate conversion of every outstanding note against your expected round price before you sign the next one, not after.

Uncapped notes and the dilution surprise

An uncapped note (discount only) sounds founder-friendly, and in a flat round it is. But founders sometimes assume “no cap” means “small dilution,” which is backwards if the company stays small and raises at a soft valuation. The bigger trap runs the other way for investors: a great up-round with no cap leaves the early investor barely better off than a latecomer, which is why sophisticated angels insist on a cap. Know which side the absence of a cap actually favours before you treat it as a concession.

Treating maturity as theoretical

Founders sign 24-month maturities expecting the Series A to land in month 18, and sometimes it doesn’t. When a note matures with no qualified financing in sight, the investor’s repayment right is suddenly live, and the company usually can’t pay. The better approach, in our view, is to negotiate a clear default-conversion mechanism (convert at a fixed fallback valuation at maturity) so a missed round doesn’t become a demand for cash you don’t have.

Ignoring the FEMA reporting clock

For cross-border notes, the Form CN deadline runs from issue, and it’s 30 days, not 30 days after you remember. Missing it doesn’t void the deal, but it forces a compounding process that delays the next round and costs money. Frankly, this gets overlooked because the note feels informal at signing. Calendar the filing the day the funds arrive.

Frequently asked questions

Is a convertible note debt or equity?
It’s debt at issue and equity after conversion. The startup records the money as a borrowing, and the investor is a creditor (not a shareholder) until a trigger event converts the note into shares. That debt character is why it carries a maturity date and a repayment right.

What is the minimum amount for a convertible note in India?
Rs 25 lakh or more in a single tranche from a single investor. A note below that floor doesn’t qualify for the deposit-rule exemption under the Companies (Acceptance of Deposits) Rules, 2014, and risks being treated as a deposit.

Can a foreign investor buy a convertible note in an Indian startup?
Yes, subject to FEMA conditions. A person resident outside India can buy convertible notes issued by a DPIIT-recognised startup, provided the sector permits the foreign investment and the issue is reported in Form CN within 30 days. Citizens of, or entities from, Pakistan and Bangladesh are barred, and land-border-country investors need prior government approval.

What is the difference between a valuation cap and a discount?
A discount is a flat percentage off the next round’s share price (a 20% discount converts at 80% of the round price). A valuation cap is a maximum valuation at which the note converts, regardless of how high the round prices the company. When a note has both, the investor converts at whichever gives them the lower price and more shares.

What happens at maturity if there’s no funding round?
The note’s terms govern. Typically the investor can demand repayment, convert at a pre-agreed fallback valuation, or agree to extend. Because most startups can’t repay in cash, a well-drafted note includes a default-conversion mechanism so maturity doesn’t trigger a repayment the company can’t meet.

Do you pay interest on a convertible note in cash?
Rarely. Interest (commonly 6% to 12%) usually accrues and is added to the principal at conversion, so the investor converts on a larger amount and receives a few more shares, rather than receiving cash interest payments along the way.

Is filing Form CN mandatory?
Yes, when a non-resident is involved. The issuing startup must report the issue of a convertible note to a foreign investor in Form CN within 30 days, through the RBI’s FIRMS portal. The same applies to a transfer of the note between a resident and a non-resident.

Can a company that isn’t a DPIIT-recognised startup issue a convertible note?
No. Only a DPIIT-recognised startup can issue a convertible note under the Indian framework. An ordinary private company without recognition isn’t eligible, and money raised by calling something a “convertible note” without that status risks being treated as an unauthorised deposit.

What is a qualified financing?
It’s the trigger event that converts the note: the startup’s next priced equity round above an agreed threshold size. When a qualified financing closes, the note converts into the same class of shares the new investors buy, at the cap-or-discount price.

Does the 10-year window reset if the note is amended?
The 10-year maximum runs from the date of issue of the note. Treat it as a hard outer limit when structuring maturity. Material amendments should be taken with legal advice, because restructuring the instrument can raise questions about whether it still qualifies as a convertible note.

Convertible note vs SAFE: which should an Indian startup use?
A convertible note is a statutory debt instrument with a maturity date, a repayment right, and the Rs 25 lakh and 10-year conditions. A SAFE (in India, usually the iSAFE) is a lighter contractual right to future equity with no maturity or interest. Notes suit investors who want debt-like protection; SAFEs suit the very earliest, lightest rounds.

Is stamp duty payable on a convertible note?
A convertible note is an instrument, and stamp duty treatment depends on the state where it’s executed. Founders should confirm the applicable state stamp duty before signing, because under-stamping can affect admissibility and create later cost.

Is conversion of a convertible note a taxable event?
Conversion of a note into equity is generally structured to be tax-neutral for the investor, but the position depends on the specific terms and the investor’s status. This is fact-sensitive, and parties should take tax advice before conversion rather than assume neutrality.

Who decides the conversion price?
The note’s terms do. The price is the lower of the cap-implied price and the discounted round price. For a non-resident investor, the conversion must also respect FEMA’s pricing guidelines, so the issue price can’t fall below the fair value at conversion.

Can a convertible note be transferred to someone else?
Yes, subject to the note’s terms and, where a non-resident is involved, FEMA reporting (Form CN within 30 days of a resident-to-non-resident or non-resident-to-resident transfer). The transfer doesn’t change the conversion mechanics already baked into the note.

What is an MFN clause in a convertible note?
A most-favoured-nation clause lets an earlier note holder adopt the better terms (a lower cap or bigger discount) of a note the startup issues later. It stops a founder from quietly offering sweeter terms to new investors without those terms flowing back to existing note holders.

References

This article is for informational and educational purposes only and does not constitute legal, tax, or financial advice. Convertible note terms, FEMA reporting obligations, and tax treatment are fact-specific and change over time. Consult a qualified company secretary, chartered accountant, or corporate lawyer before issuing or investing in a convertible note. Last verified: 12 June 2026.

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