Convertible notes in India

By Abha Lohia · Startup Decoded

A convertible note is a short-term loan that a startup does not repay in cash. It converts into shares when the company raises its next priced round, usually at a discount to that round's price.

What is a convertible note?

A convertible note is a way to take an investor's money now and agree on the share price later. On paper it is a loan: the investor lends money, the note carries interest, and it has a maturity date. But the plan is not repayment. The plan is that the note converts into shares when the startup raises a proper equity round, called the qualified financing.

Founders like it because it is fast. A priced round needs a valuation, a long term sheet and detailed legal work. A note can be signed in days. Investors like it because they get shares at a better price than the new investors who come in at the next round, as a reward for taking the early risk. It is common when a startup needs a small bridge of money before it has enough proof to agree a valuation.

What are the main terms?

Principal is the amount lent. Interest is a simple annual rate on that principal, which is added to the amount that converts. Maturity is the date by which the note must be converted or repaid, commonly twelve to twenty-four months, though it can be longer.

The discount gives the note holder a lower price than the new investors, for example 20 per cent off. The valuation cap sets the highest valuation at which the note converts, so the early investor is protected if the next round is priced very high. Most notes include both, and the note converts at whichever gives the investor the lower price. The qualified financing clause says how big the next round must be to trigger conversion, and what happens if it never comes.

How does the conversion work?

When the qualified round closes, the note's principal and accrued interest are divided by the conversion price to give the number of shares. The conversion price is the lower of the discounted round price and the cap price.

Because the note holders convert before the new money counts, they dilute the founders and earlier shareholders. Founders must model this in advance. A series of notes with different caps and discounts can pile up, and by the time the priced round arrives, the combined conversion can be larger than expected. The example below shows one conversion.

What happens if the next round never comes?

If the note reaches maturity without a qualified round, the holder can usually ask for the money back with interest, or the holders and the company can agree to extend the note or convert it at a set price. A company that cannot repay is in trouble, because the note is debt.

This is the main risk for founders. A weak market can leave a startup unable to raise, with notes falling due at the same time. Good practice is to choose a long enough maturity, to keep the size of notes sensible, and to talk to holders early if a round is delayed. Many investors will agree to extend, because forcing a company into default usually loses them their money.

What are the rules for convertible notes in India?

Indian law treats a convertible note in a narrow way. Under the Companies (Acceptance of Deposits) Rules, 2014, a DPIIT-recognised startup can raise money through a convertible note without it being counted as a deposit. As of October 2026, the commonly cited conditions are a minimum of ₹25 lakh from one person in a single tranche, and conversion into equity or repayment within a period of up to ten years, which was earlier five years. Check the current text before relying on these figures.

DPIIT recognition is therefore the key. A company without recognition cannot use this route in the same way and would normally use other instruments, such as compulsorily convertible debentures or preference shares. The note should also be recorded as the Companies Act requires, and a resolution of the board is needed to issue it.

What about foreign investors?

For non-resident investors, the Foreign Exchange Management (Non-debt Instruments) Rules, 2019, allow a DPIIT-recognised startup to issue a convertible note to a person outside India. Commonly cited conditions are a minimum investment of ₹25 lakh per investor in a tranche, that the startup works in a sector where foreign investment is allowed under the automatic route, and that the note converts or is repaid within ten years of issue, a limit that was five years in earlier versions of the rules.

The issue has to be reported to the RBI through the company's authorised dealer bank. Reporting deadlines and forms have been amended several times, so consult a professional for the current form and timeline. Also remember that when the note converts, the share price must meet the FEMA pricing guidelines, which set a floor based on a fair valuation.

How does a note compare with a priced round or a SAFE?

A priced round sets a valuation today and issues shares today. It costs more in legal fees and takes longer. A note defers the valuation. A SAFE, or in India an iSAFE, is similar to a note but is not a loan: it has no interest and no maturity date. Notes therefore carry a debt-like risk that SAFEs do not.

In India, notes are better tested in law than SAFEs, because the Companies Act and FEMA both mention them. That is one reason lawyers often prefer a note, or a compulsorily convertible instrument, over a SAFE for formal deals, especially with foreign money. The next guide in this series covers SAFEs.

What should founders watch for?

Model the cap table after conversion. Watch for stacking of many notes. Make sure the maturity date has room. Understand the interest: it is usually simple interest that converts into shares and does not need to be paid in cash. Check tax. Interest accrued on a note is income for the investor and a cost for the company, and conversion at a discount can have tax effects for both sides.

This guide is general information on a topic where rules change. Please check with a lawyer or chartered accountant before issuing or buying a convertible note.

The first mistake is raising too many notes with different caps, which makes the cap table hard to predict. The second is setting a cap too low, because it is easy to agree in a hurry, and regretting the dilution at the next round. The third is ignoring the maturity date until it arrives.

A simple discipline helps: keep a table of every note, its cap, discount, interest and maturity, and update it at each board meeting. Founders who track this avoid unpleasant surprises when the priced round arrives.

Until it converts, a note appears in the company's books as a liability, and the interest builds up as an expense. This can affect loan agreements and make a balance sheet look weaker than it is. After conversion, the amount moves into equity and the share capital account.

Tax treatment depends on the structure, and the rules around the conversion price, interest and capital gains have changed over the years. A chartered accountant should model both the company's and the investor's position before the note is signed, since tax on interest is due even when no cash has been paid.

A worked example

Example with made-up numbers. An angel invests ₹1 crore in a convertible note at 8 per cent simple interest with a 20 per cent discount and a ₹20 crore valuation cap. One year later the startup raises a Series A at a ₹40 crore valuation before the new money. The note with interest is ₹1.08 crore. The discount would give a price equal to a ₹32 crore valuation (80 per cent of ₹40 crore). The cap gives a price equal to a ₹20 crore valuation. The lower is the cap, so ₹1.08 crore converts as if the company were worth ₹20 crore, roughly 5.4 per cent of the shares before the new round. At the discount it would have bought roughly 3.4 per cent. A Series A investor who buys at ₹40 crore pays double the cap price.

Recent examples on StopDown

Lissun raises Rs 2.77 crore from existing investors 17 June 2026
Satark AI raises pre-seed funding via convertible notes 6 April 2026

Questions people ask

Is a convertible note debt or equity?

It starts as debt: a loan with interest and a maturity date. It is meant to convert into equity at the next funding round, so it behaves like a delayed equity investment.

What is a valuation cap on a convertible note?

It is the highest company valuation at which the note converts. If the next round is priced above the cap, the note holder still converts at the lower cap price, which rewards early risk.

Who can issue a convertible note in India?

The exemption from the deposit rules is aimed at DPIIT-recognised startups. Check with a professional for the conditions as of today, since limits such as the minimum amount and tenure have changed over time.

What happens if a convertible note matures before a funding round?

The holder can ask for repayment with interest, or the company and holder can agree to extend the date or convert at a fixed price. Since it is debt, a failure to repay can lead to a dispute.

Do convertible notes dilute founders?

Yes, when they convert. Notes with a low cap and a discount give the holder more shares, and several notes can add up, so founders should model the result before signing.