"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

The convertible instruments Indian law recognises for foreign equity investment

Under the Foreign Exchange Management (Non-Debt Instruments) Rules, 2019 ("NDI Rules"), the convertible "equity instruments" a non-resident can subscribe to in an Indian company are Compulsorily Convertible Preference Shares (CCPS) and Compulsorily Convertible Debentures (CCDs) — the Rules define them as "fully and mandatorily convertible" and fully paid (Rule 2(k), Explanation (i)); share warrants are also equity instruments. The word that matters is mandatorily. The instrument must convert into equity — there can be no option for the investor to demand repayment in cash instead. An optionally convertible instrument is a "hybrid security" (Rule 2(x)), not an equity instrument, and money the holder can demand back sits outside the equity route (the External Commercial Borrowing framework; confirm under the FEMA borrowing regulations). 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 Rules 2(1)(e) and 18 of the NDI Rules 2019, a Convertible Note can only be issued by a "startup company": a private company identified as a "startup" under notification G.S.R. 127(E) dated 19 February 2019 (Rule 2(an)). The conditions are strict:

• The startup must receive at least ₹25 lakh in a single tranche from the non-resident (Rule 18(1)).
• The note is repayable at the holder's option or convertible into equity within a period not exceeding ten years from the date of issue (Rule 2(e), as substituted by S.O. 1802(E) dated 12.04.2022).
• 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

Equity instruments issued to a non-resident by an unlisted company cannot be priced below a valuation "as per any internationally accepted pricing methodology for valuation on an arm’s length basis duly certified by a Chartered Accountant or a Merchant Banker registered with the Securities and Exchange Board of India or a practising Cost Accountant" (Rule 21(2)(a)(ii), NDI Rules). A "we'll figure out the price at conversion" note offends this: for convertible equity instruments "the price/ conversion formula of the instrument should be determined upfront at the time of issue", and the conversion price cannot be lower than the fair value worked out at issue (Rule 21(2)(a), Explanation). 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). That means a private placement offer and application (s.42(3)), a special resolution of shareholders for each offer (Rule 14(1), Companies (Prospectus and Allotment of Securities) Rules, 2014), a PAS-4 private placement offer cum application letter (Rule 14(3)), 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 (s.42(8); Rule 14(6)). Blow the 60-day window and the application money must be repaid within 15 days; after that it is repayable with interest at 12% per annum from the sixtieth day (s.42(6)). Until allotment, that money must sit in a separate bank account in a scheduled bank (s.42(6) proviso).

Practical implications — what actually happens when this is ignored

The FEMA reporting failure is the one that hurts. An issue of equity instruments to a non-resident that is reckoned as FDI must be reported to the RBI through Form FC-GPR filed on the FIRMS portal not later than thirty days from the date of issue (Regulation 4(1), FEMA 395/2019). A convertible note has its own reporting (Form CN), to be filed within 30 days of issue (Regulation 4(12), FEMA 395/2019). Miss the window and you owe a late submission fee as computed by RBI under the LSF framework (Regulation 5, FEMA 395/2019). The LSF covers delays in reporting (Regulation 5); other contraventions (wrong instrument, wrong route) may be taken through compounding under section 15 of FEMA: an application to the Reserve Bank with a fee of ₹10,000 plus GST, and a compounding order due within 180 days of a complete application (Rules 4(4) and 8(2), Foreign Exchange (Compounding Proceedings) Rules, 2024).

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 return-of-deposit reporting under the Deposit Rules (confirm the current due date on MCA21). 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. Get an arm’s length valuation by an internationally accepted methodology, certified by a CA, a SEBI-registered Merchant Banker or a practising Cost Accountant (Rule 21(2)(a)(ii)), before issue. This sets your floor price and protects the conversion formula.
• Run the Section 42 private placement. Pass the special resolution (Rule 14(1)), issue PAS-4 (Rule 14(3)), collect money into a separate bank account (s.42(6) proviso), and allot within 60 days (s.42(6)).
• File PAS-3 within 15 days of allotment on MCA21 v3 (Rule 14(6)).
• Report to the RBI. File Form CN within 30 days of issuing a convertible note, or Form FC-GPR not later than thirty days from the date of issue of equity instruments (Regulation 4(1), FEMA 395/2019), 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 reporting the RBI prescribes for it (confirm the form and window on FIRMS).
• If you already messed it up, don't compound the delay. Compute the LSF, or prepare a compounding application, and file voluntarily.

FAQ

Can I just use a US SAFE and convert it to CCPS at my next round?
Not cleanly. A SAFE is not a recognised Indian instrument, and the inbound money still has to be reported correctly the moment it arrives. Retrofitting almost always creates a pricing or reporting breach that surfaces in diligence. Issue a compliant instrument from the start.

What is the minimum ticket for a Convertible Note?
₹25 lakh in a single tranche from the non-resident investor. Below that, the Convertible Note route is unavailable and you must use CCPS or CCDs.

How long do I have to report foreign investment to the RBI?
30 days. Form CN within 30 days of issuing a convertible note; Form FC-GPR not later than thirty days from the date of issue of equity instruments (Regulation 4(1), FEMA 395/2019) — both on the FIRMS portal. Missing it triggers a Late Submission Fee.

Is a convertible note "debt" that I have to repay?
A FEMA Convertible Note is debt that is repayable at the holder's option or convertible into equity within ten years (Rule 2(e)); CCPS and CCDs are mandatorily convertible (Rule 2(k)), with no cash-repayment option. Outside the startup Convertible Note route, an instrument that lets the investor demand money back is not an equity instrument (confirm the debt route under the FEMA borrowing regulations).

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