RBI permits start-ups to borrow up to $3 million overseas in a fiscal year

The Reserve Bank of India (RBI) has permitted start-ups to raise external commercial borrowings (ECBs) of up to $3 million in a financial year, a move aimed at boosting innovation and promoting entrepreneurship.

For raising ECB, an entity should be recognised as a startup by the central government as on date of raising ECB. (The parameters for considering an entity as a startup have been published in the Official Gazette on 18 February 2016 by the Government of India).

The minimum average maturity period of the ECB will be 3 years.

The lender / investor should be a resident of a country who is either a member of Financial Action Task Force (FATF) or a member of a FATF-Style Regional Bodies.

The ECB to be raised should not be from a country identified in the public statement of the FATF as a jurisdiction having a strategic Anti-Money Laundering or Combating the Financing of Terrorism deficiencies to which counter measures apply or a jurisdiction that has not made sufficient progress in addressing the deficiencies or has not committed to an action plan developed with the Financial Action Task Force to address the deficiencies.

Overseas branches / subsidiaries of Indian banks and overseas wholly-owned subsidiary / joint venture of an Indian company will, however, not be considered as recognised lenders under this framework.

The borrowing can be in the form of loans or non-convertible, optionally convertible or partially convertible preference shares. The funds should come from a country which fulfils the stipulated eligibility conditions.

The borrowing should be denominated in any freely convertible currency or in Indian rupees or a combination thereof. In case of borrowing in rupee, the non-resident lender should mobilise the amount through swaps / outright sale undertaken through an AD Category-I bank in India.

The borrowing per startup will be limited to $3 million or equivalent per financial year either in rupee or any convertible foreign currency or a combination of both.

All-in-cost should be mutually agreed between the borrower and the lender. End use of the funds can be any expenditure in connection with the business of the borrower.

Conversion of the ECB into equity is freely permitted, subject to regulations applicable for foreign investment in startups.

The choice of security to be provided to the lender is left to the borrowing entity. Security can be in the nature of movable, immovable, intangible assets, including patents, intellectual property rights, financial securities, etc, and shall comply with foreign direct investment / foreign portfolio investment / or any other norms applicable for foreign lenders / entities holding such securities.

Issuance of corporate or personal guarantee is allowed. Guarantee issued by a non-resident is allowed only if such parties qualify as lender under the rules.

Issuance of guarantee, standby letter of credit, letter of undertaking or letter of comfort by Indian banks, all India Financial Institutions and NBFCs is not permitted.

The overseas lender, in case of rupee denominated ECB, will be eligible to hedge its rupee exposure through permitted derivative products with AD Category – I banks in India. The lender can also access the domestic market through branches/ subsidiaries of Indian banks abroad or branches of foreign bank with Indian presence on a back to back basis.

In case of borrowing in rupee, the foreign currency - rupee conversion will be at the market rate as on the date of agreement.

Other provisions like parking of ECB proceeds, reporting arrangements, powers delegated to AD banks, borrowing by entities under investigation, conversion of ECB into equity will be as included in the ECB framework. However, provisions on leverage ratio and ECB liability: equity ratio will not be applicable.

It may be noted that startups raising ECB in foreign currency, whether having natural hedge or not, are exposed to currency risk due to exchange rate movements and hence are advised to ensure that they have an appropriate risk management policy to manage potential risk arising out of ECBs.

India, with about 4,700 start-ups, saw addition of about 1,400 new start-ups in 2016, an 8-10 per cent year-on-year growth, according to a report published by industry lobby body Nasscom and consultancy firm Zinnov.

The report estimates that the number of start-ups in India will more than double to about 11,000 by 2020, employing a 210,000-250,000-strong workforce.

Though India is the third largest start-up hub, it is less than one-tenth of the US, which is home to about 52,000 start-ups.

While the number of start-ups increased this year, access to funds continues to be a major challenge for homegrown start-ups. Investors have become increasingly cautious about their bets. Unlike the heady days of 2014 and the first half of 2015, investors are now releasing funds in tranches subject to attaining certain business metrics.