Convertible Notes in Southeast Asia and India – What Founders Should Know

Convertible notes have increasingly become a popular funding option for early-stage and even late-stage companies in Southeast Asia and India, often seen as a bridge until the next round of equity financing. While convertible notes in the US venture capital space typically include familiar terms like “conversion caps” and “discounts” (refer to our primer and FAQ on convertible debt for a comprehensive overview), the lack of established market norms and investor-favorable conditions in Southeast Asia and India have led to the emergence of bespoke terms that can pose challenges for founders. This article highlights common US terms found in these markets, while focusing on additional unique terms that are increasingly observed.

Operational and financial covenants

Convertible notes in Southeast Asia and India frequently come with extensive operational and financial covenants that may not align with the more flexible practices seen in US startup financing. These covenants often restrict companies from undertaking significant corporate actions – such as issuing new securities, amending dividend policies or altering their capital structure. Financial covenants can impose additional burdens, like limiting the company’s ability to incur new debt or mandating that certain financial ratios be maintained throughout the loan’s duration.

Founders should be mindful of several potential issues associated with these covenants. Firstly, managing compliance can be challenging, especially when tracking a parallel list of shareholder consent requirements. Secondly, by agreeing to such covenants, founders may inadvertently grant convertible noteholders what can be viewed as backdoor veto rights, which could hinder the company’s decision-making processes. Lastly, the rigorous financial covenants may be particularly hard for development-stage companies to meet, significantly increasing the risk of default.

From an investor’s perspective, imposing operational and financial covenants serves to maintain the risk profile within acceptable parameters. Given that convertible notes are typically designed for eventual conversion into equity, these covenants allow investors to retain some level of influence over the company’s capital structure, ensuring it remains an attractive investment opportunity when conversion occurs.

Representations and warranties

In addition to operational and financial covenants, convertible noteholders may request an extensive set of representations and warranties about the company’s affairs. This request often resembles the comprehensive representations typically required in US equity financings, rather than the lighter obligations usually associated with convertible debt. As a result, founders and companies risk “foot faults” – making incorrect representations that could lead to breaches or defaults under the loan documents. This risk is exacerbated by the perception that convertible notes are a straightforward, low-effort means of securing funding, leading founders to neglect a thorough review of the documentation. Failing to carefully scrutinize and negotiate these terms can expose founders and companies to unnecessary future risks.

Jurisdiction-specific features

Additionally, founders must consider jurisdiction-specific requirements that could impact their ability to raise capital through convertible notes. For instance, in India, foreign exchange restrictions limit the issuance of notes to foreign investors, compelling Indian-incorporated companies to primarily engage “onshore” angel investors. Legal counsel familiar with local regulations is crucial for navigating these complexities and ensuring compliance.

Conclusion

Given the diverse – and sometimes complex – terms of convertible notes in Southeast Asia and India, founders should approach these agreements with the same level of diligence typically reserved for equity fundraising. Careful consideration of any bespoke or unusual terms required by convertible note investors is essential to mitigate risks and protect the long-term interests of the company.