What are SAFE & Convertible Notes in India?

Building a startup starts by raising funds which becomes even more urgent when typical investments may not provide the best results. Many founders and investors in India’s growing startup scene are now using SAFE and Convertible Notes because of their adaptability, ease of use and simpler legal procedures.

This guide covers the idea of SAFE & Convertible Notes, their structure, benefits, legal status and any differences they have in India. We will also find out when it’s best for startups to use each and what to keep an eye out for.

1. An Introduction to Getting Started with Startup Financing

Most of the time, startups are funded through seed funding, angel investments or venture capital. Typically, these investments used to involve long and detailed talks about valuing the business. Nonetheless, startups in the early stages have a hard time agreeing on their value due to lack of proven results.

Therefore, instruments such as SAFE and Convertible Notes were developed to avoid discussing valuation until a future funding event. Using these tools, startups can get investment money fast, but they don’t give away ownership right away.

2. What does a SAFE mean?

SAFE means Simple Agreement for Future Equity. Y Combinator in the U.S. created SAFE which makes it possible for investors to provide cash for equity grants that will be determined in a future priced round.

What are the most important elements of SAFE?

• Both interest and the maturity date are unknown
• No immediate shares are given away.
• They become shares when a future round of funding happens
• Many times valuation caps and discounts are applied.

SAFE, created in the U.S., is becoming popular with Indian startups and investors thanks to its flexible and simple design.

3. What do Convertible Notes mean?

When a company borrows by issuing a Note, the debt will be changed into equity if and when it raises a qualified funding round at a future date. In 2017, the Companies Act, 2013, passed by the MCA, formally ercognized Convertible Notes in India.

Essential Points about Convertible Notes

• Considered a loan that will turn into stocks once it converts
• Most of these investments come with interest.
• The papers should mature on a date within five years.
• Sometimes, the founders get a certain valuation cap and discounts for shares
• A qualified financing or liquidity event is when a conversion can occur.

At this time, regulatory clarity about Convertible Notes stands above that of SAFE in the Indian legal system.

4. Are SAFE and Convertible Notes Legally Valid in India

A look at safety in India:

The approach known as SAFE is still developing in India. Because SAFE does not have the status of an official corporation under Indian laws, its legitimacy could be challenged some cases. Yet, many investors and founders are smart enough to modify the terms to comply with Indian law.

Many Indian startups add more details, enforceability words and optional letters to SAFE agreements to keep risks low for both sides.

What Are Convertible Notes in India?

Startups listed under the Department of Promotion of Industry and Internal Trade can issue Convert Notes due to an MCA announcement dated April 11, 2017. A startup in India is allowed, under law, to give Convertible Notes worth at least ₹25 lakh to a person (whether resident or non-resident) which will change into equity or be returned after a maximum of 5 years.

Therefore, Convertible Notes are considered more secure legally than SAFE by Indian law.

5. Key Differences Between SAFE & Convertible Notes

Both SAFE and Convertible Notes aim to simplify early-stage fundraising but differ in their structure and regulatory framework.

6. Why do many startups opt for SAFE and convertible notes?

Reasons to choose SAFE include:

• Bullet financial donations require organizing events with speed and ease.
• The financing process doesn’t require negotiation of valuation first
• There are no dates when the loans need to be paid back.
• The investor focuses on creating value that fits the founder’s plan for the long run.

Why Using Convertible Notes is Useful

• Indian law treats them as valid and is used for enforcement
• Best choice for investors interested in receiving interest and converting it in a set amount of time
• Offers advantages in the event of disagreements or the business winding up
• Useful for raising funds in later early-stage stages

When starting up in India, companies choose Tible Notes for documentation, but choose SAFE in early, informal or friendly funding rounds.

7. Important Points to Put in the Contract

You should have all of these clauses covered, no matter if you choose SAFE or Convertible Notes:

1. Limits the maximum price at which the shares begin to convert
2. Discount Rate: Lowers the price paid for the company in the next valuation
3. A certain amount of funding is needed before conversion can happen.
4. Conversion Mechanism: How shares can be changed from common to preferred
5. The terms apply to IPOs, mergers and acquisitions.
6. What will happen if the company does not meet the requirements for conversion

These terms guard the interests of both founders and investors, helping everyone to understand each other.

8. You should keep taxes and FEMA in mind.

For SAFE:

SAFE is not acknowledged by Indian law, so it falls in between the rules of FEMA and Income Tax laws. People from other countries should be careful when putting their money into real estate. When not planned well, it can be viewed as hidden owner’s equity or debt and place the business at risk of paying penalties.

If the company’s shares are purchased using Convertible Notes:

Convertible Notes are governed by FEMA (for foreign investors) and by the Companies Act. Yet, founders need to:

• Follow the guidelines from FEMA about pricing.
• Complete Form CN and give it to the RBI for your investments.
• Have all required conversion or repayment made within 5 years

If these rules are not followed, it may be difficult to comply with regulations.

9. When to Use SAFE or Convertible Notes?

Founders must align funding instruments with both their business goals and the investor’s expectations. Consulting a legal expert is always advisable.

10. Sample Clauses from Indian Context

Here is a clause that appears in a Convertible Note agreement in India:

“This Note shall be converted into equity shares upon the occurrence of a Qualified Financing of at least INR 2 crore, at a discount of 20% on the valuation applicable to such round, or at a valuation cap of INR 10 crore, whichever is lower.”

If SAFE were to have a comparable clause, it might say this:

“The Investor shall receive shares in the next equity financing round, at a valuation cap of INR 8 crore or a discount of 15%, whichever provides the greater benefit to the Investor.”

Indian terms, INR payment limits and aligned regulations matter a lot in the formation of agreements that work.

11. Stories from Indian Startups

• Ketto started with an early round through a Convertible and this note converted when the company raised pre-Series A money.

• UrbanClap (now Urban Company) chose a SAFE-like model to close funding more quickly from angel investors for its seed round.

• Before getting supported by institutional investors, Razorpay raised funds with Convertible Notes which helped them put off discussions about their valuation.

It shows that these instruments have flexibility and are valuable tools in the Indian startup world.

12. Managing Risks

The SAFE platform has its own set of risks.

• Because legal recognition is missing in India
• They sometimes result in arguments over future budgets.
• Falling under FEMA regulations in real estate sales

Mitigation: Use custom SAFE agreements with legal vetting and domestic investors only.

Disadvantages of Convertible Notes:

• There is greater complexity today in both taxation and accounting.
• A credit with exclusive features will have repayment risk if conversion is not achieved.
• Conflicts brought on by potential investors and founders

Define simple terms, follow regulations from RBI and MCA and tell investors about any changes soon.

13. The future of SAFE & Convertible Notes in India

As India’s startup situation grows more mature, the methods for obtaining funding are also changing. Soon, regulators could propose rules for SAFE instruments, as accelerators and incubators increasingly start using worldwide best practices.

Even now, Convert Notes are used the most in early-stage funding in India because they are recognized by law and secure for investors.

Before choosing, investors and founders need to gather information, speak with law experts and pick the option that combines being simple, following the rules and minimizing risks.

Conclusion:

Using SAFE or Convertible Notes, Indian startups can gain early funding without discussing complicated issues of equity. Although SAFE makes things speedy and simple, Convertible Notes have clear legal reporting and organized structure.

You should make your decision between SAFE and Convertible Notes using the following factors:

• The readiness of the company to obey laws and regulatory rules
• The willingness and preferred ways of investors to manage risks
• Does raising more money faster come at the expense of security?

People forming startups should set up these instruments with care, keeping them Indian law-compliant and always keep their cap table clear to succeed with raising additional funds.

FAQs

1. Are SAFE agreements legally valid in India?
SAFE agreements are not formally recognized in India but can be used with customized legal language and local investors.

2. What’s the minimum investment required for Convertible Notes in India?
Convertible Notes in India require a minimum investment of ₹25 lakhs per investor.

3. Which is better for early-stage funding: SAFE or Convertible Notes?
SAFE is ideal for quick, informal rounds, while Convertible Notes offer legal clarity and investor protection in larger rounds.