Raising early-stage capital is one of the toughest — and most legally misunderstood — challenges for Indian startups. Between convertible notes, SAFEs, and CCPS, founders often sign investment documents without fully understanding their implications under the Companies Act, FEMA, and RBI guidelines. This guide simplifies how these startup funding instruments actually work in India — when to use them, what laws govern them, and how investors typically structure their deals.
What are Startup Funding Instruments and Why Do They Matter?
Startup funding instruments are legal tools — such as convertible notes, SAFEs, and CCPS — that help investors fund startups before valuation is fixed. They balance flexibility for founders with protection for investors under Indian corporate and foreign exchange laws.
Every investment transaction in a startup must comply with both the Companies Act, 2013 and, if foreign investment is involved, FEMA (Non-Debt Instruments) Rules, 2019. In early stages, startups rarely have a clear valuation, so investors prefer convertible or hybrid instruments that convert into equity later.
These instruments — Convertible Notes, SAFEs (Simple Agreements for Future Equity), and CCPS (Compulsorily Convertible Preference Shares) — are designed to achieve that balance between speed, flexibility, and regulatory compliance.
What is a Convertible Note under Indian Law?
A convertible note is a debt instrument issued by a DPIIT-recognized startup, repayable or convertible into equity within 5 years. It’s legally allowed under FEMA and offers flexibility before valuation is determined.
Convertible notes were introduced in India in 2017 through a notification by the Reserve Bank of India, allowing foreign investors to subscribe to them under FEMA.
Key legal conditions include:
- The issuing company must be a DPIIT-recognized startup.
- Each investor must invest ₹25 lakh or more in a single tranche.
- The note must be convertible or repayable within 5 years.
Convertible notes are often used in pre-seed and seed rounds, giving startups breathing room before fixing valuation. Upon the next qualified funding event, the note automatically converts into equity — typically at a discount (e.g., 15–20%) to the next round’s price.
📎 Related Read: Difference Between Private Limited and LLP in India – Legal and Tax Viewpoint
📎 Related Read: Post-Incorporation Compliance Checklist for Startups
What is a SAFE and Is It Legal in India?
A SAFE (Simple Agreement for Future Equity) gives investors the right to equity in the future without being a loan or share now. It’s popular in the US but not legally recognized under Indian company or FEMA law.
The SAFE, created by Y Combinator in the US, simplifies early-stage funding — it’s not debt, not equity, and doesn’t accrue interest. However, Indian law doesn’t currently recognize “future equity rights” without an underlying instrument like shares or debentures.
Therefore, Indian startups can’t technically issue SAFEs unless structured as convertible notes or CCPS, which comply with the Companies Act and FEMA.
That said, domestic angel investors sometimes use SAFEs as informal agreements between resident parties, but such instruments carry enforceability and compliance risks. The safer (and legally valid) Indian equivalent is the Convertible Note.
Understanding CCPS (Compulsorily Convertible Preference Shares)
CCPS are preference shares that must convert into equity within a defined period. They’re the most common instrument for startup investments in India, used in Series A and later rounds.
CCPS are governed by the Companies Act, 2013 (Sections 43 and 55) and offer both regulatory legitimacy and investor protection. Investors prefer CCPS because they carry:
- Preferential dividend rights (if declared),
- Liquidation preference (priority on exit or winding up),
- Conversion rights into equity at a pre-agreed ratio or event.
For foreign investors, CCPS must comply with FEMA pricing guidelines, meaning the conversion price can’t be below fair market value (FMV) determined by a merchant banker or CA (Category I).
In practice, CCPS are used from Series A onwards, when valuation is established, and investors want structured rights through Shareholders’ Agreements (SHA) and Share Subscription Agreements (SSA).
Convertible Notes vs. CCPS: Which is Better for Startups?
Convertible Notes are ideal for early-stage startups without fixed valuation. CCPS suit growth-stage investments where valuation, rights, and governance are clearly defined.
Detailed explanation
| Feature | Convertible Note | CCPS |
| Nature | Debt instrument | Equity (preference share) |
| Stage | Early-stage / pre-seed | Growth / Series A onwards |
| Conversion | At next funding event or maturity | Fixed conversion ratio or event |
| Valuation | Deferred | Pre-determined |
| Legal Basis | FEMA + DPIIT startup norms | Companies Act + FEMA pricing rules |
Convertible Notes are fast and founder-friendly, while CCPS are structured and investor-protective. The right choice depends on your stage, investor profile, and valuation certainty.
What Legal Documents Govern Startup Investments?
Every investment uses a Term Sheet (summary of deal terms), followed by legally binding documents — the Share Subscription Agreement (SSA) and Shareholders’ Agreement (SHA).
- Term Sheet: Non-binding summary of deal terms — valuation, investment amount, exit rights, board structure, liquidation preference.
- Share Subscription Agreement (SSA): Binding agreement governing issue and allotment of shares or notes.
- Shareholders’ Agreement (SHA): Defines rights and obligations between founders and investors, including governance, drag-along, and exit clauses.
A well-drafted SHA protects both parties and prevents future disputes — especially on control, dilution, and exit.
📎 Related Read: Legal Framework of ESOPs in India (2025 Guide)
📎 Related Read: Difference Between ESOP, Sweat Equity, and Phantom Stock in India
Why FEMA Compliance Matters for Startup Funding
Foreign investments — even from overseas angels — must comply with FEMA, RBI filings, and valuation norms. Non-compliance can attract penalties or compounding under FEMA, 1999.
Every foreign investment, whether via Convertible Note or CCPS, must be reported to the RBI through the FIRMS portal within 30 days of issue. Key FEMA filings include:
- Form CN: For Convertible Notes issued to non-residents.
- Form FC-GPR: For shares (including CCPS) issued to non-residents.
- Form DRR: For transfer between residents and non-residents.
Failure to comply may lead to FEMA contraventions, which can later block exits or investor payouts. Therefore, startups must consult professionals before accepting foreign capital.
The Founder’s Takeaway
Convertible Notes and CCPS are not just legal forms — they determine your control, valuation, and investor relationship. Early mistakes in structuring can lock founders into restrictive terms or non-compliant investments. Always ensure the instrument chosen aligns with your startup’s stage, investor type, and compliance capability.
For early rounds, Convertible Notes offer speed and flexibility. For larger, priced rounds, CCPS provide structure and investor confidence. SAFEs, though convenient abroad, remain legally risky in India.
Frequently Asked Questions (FAQs)
Can Indian startups issue convertible notes to foreign investors?
Yes, but only if recognized as a DPIIT startup and each investor invests at least ₹25 lakh in a single tranche.
Are SAFEs legally valid in India?
Not officially. They’re not recognized under the Companies Act or FEMA and should be replaced by convertible notes or CCPS.
Can CCPS be issued to Indian investors without valuation?
No. Even for resident investors, a valuation certificate is required to comply with the Companies Act and pricing guidelines.
