Cross-Border Strategies For Founders In SEA And India On Leveraging Convertible Notes

In the dynamic start-up landscapes of Southeast Asia (SEA) and India, convertible notes have become a favoured tool for initial fundraising efforts. These short-term debt instruments enable founders to obtain funding without having to establish a company valuation right away, postponing equity conversion until a later priced round. This adaptability is especially attractive in areas where valuations can vary significantly due to economic instability, regulatory challenges, and emerging venture capital markets.

For entrepreneurs, convertible notes provide speed allowing deals to close within weeks instead of months and lower legal expenses in comparison to full equity rounds. In SEA, countries like Singapore and Indonesia frequently utilise standardised templates such as the KISS (Keep It Simple Security), while in India, they conform to RBI regulations for seed funding. However, beneath this apparent simplicity lies a web of complexity. Local practices often favour investor-friendly conditions, featuring stricter covenants and broader liabilities than those seen in the U.S. counterparts. Founders face the potential risks of operational restrictions, dilution challenges, and compliance issues that could hinder growth. This article examines these risks, providing a legal-business perspective to help founders navigate them effectively.

Understanding Convertible Notes

Convertible notes are a popular fundraising instrument for start-ups in Southeast Asia and India, acting as short-term loans that transition into equity shares upon certain events, such as a qualified financing round (often a Series A raising $1-2 million). The principal amount accrues modest interest, typically ranging from 1-2% annually in SEA, compounding until the conversion occurs. A usual maturity period lasts between 18-24 months and if this period is not met, notes may convert at a discount or require repayment, potentially putting pressure on cash flows. Investors enjoy a discount rate, generally between 15-25% off the share price in the subsequent round, rewarding their early investment risk, while a valuation cap guarantees they receive a greater number of shares if the company's valuation skyrockets. In SEA and India, these notes frequently contain comprehensive representations and warranties regarding the company's legal and financial position, heightening the risk of breach if founders are not diligent. This structure balances flexibility with investor safeguards but introduces complexities that require careful management.

The Regional Landscape

SEA's entrepreneurial landscape, driven by over $10 billion in yearly VC investments, leans towards convertible notes due to their cross-border versatility. Singapore, a hub for fintech, relies on the use of KISS templates to enhance operational efficiency, while Indonesia and Vietnam face challenges with foreign ownership restrictions imposed by OJK and SBV regulations, respectively. In Malaysia, the MSC status facilitates technology funding but requires approval from Bursa Malaysia for larger transactions. Throughout SEA, convertible notes serve as a means to address pre-seed funding gaps, though regulations differ by region, for instance, Indonesia mandates notarial deeds to ensure enforceability.

In India's start-up ecosystem, with more than 100,000 ventures, convertible note was initially established by the Ministry of Corporate Affairs (MCA) through a Notification dated 29^th June 2016, which amended Rule 2 of The Companies (Acceptance of Deposits) Rules, 2014¹. According to this amendment, any amount of INR 25 Lakh or more received by a Start-up Company in the form of a Convertible Note would thereon be classified as an exempted deposit. These instruments are particularly suited for angel investment rounds, yet they must comply with FEMA's automatic route, sectoral FDI restrictions (such as the 49% cap in defense), and SEBI regulations for public offerings. The recent amendments to FEMA in April 2024 have intensified the requirements for source-of-funds disclosures, aiming to prevent round-tripping via offshore tax havens².

Key Terms and Structure

Standard terms such as discounts and caps remain in place, yet regional modifications introduce additional complexity. In Southeast Asia, "majority-in-interest" provisions let noteholders (by principal amount) amend terms, avoiding veto deadlocks but potentially risking founder isolation. Qualified financing benchmarks (e.g., a minimum of $1 million) create significant triggers, although low thresholds may result in hasty conversions. India mandates five-year conversion periods (which can be extended to 10), with pricing aligned to the RBI's fair market value criteria, typically validated by certified accountants. Representations and warranties in this context encompass IP ownership and litigation disclosures, reflecting the standards seen in equity transactions. Founders must negotiate "no-shop" clauses that restrict concurrent fundraising efforts, a common practice in both regions to safeguard investor commitments.

Jurisdiction-specific Considerations

Southeast Asia

The registration process through Singapore's ACRA simplifies documentation, but operating in multiple jurisdictions (such as subsidiaries in Indonesia) requires adherence to bilateral treaties. Founders encounter foreign exchange restrictions in Vietnam, where the SBV limits foreign debt to 50% of equity. Tax treaties help reduce withholding taxes (which range from 10-15% on interest), yet the potential for double taxation remains without appropriate structuring. In Indonesia, Law No. 8/1995 mandates that shareholder approval is necessary for conversions that exceed 10% of equity.

India

Compliance with FEMA is non-negotiable: file Form CN within 30 days of issuance, file FC-GPR after conversion, and provide annual FLA returns. Start-ups operating in sectors allowed through the automatic route (like e-commerce) can avoid approval processes, but pricing below discounted cash flow valuations may attract scrutiny. Board resolutions as per Companies Act Section 62(3) and e-Form MGT-14 submissions are standard practices, although foreign notes cannot surpass FDI limits without approval from DPIIT.

Key Risks for Founders

• Regulatory and Compliance Risks: Non-compliance can severely hinder operations. In India, violations of FEMA lead to investigations by the Enforcement Directorate, imposing penalties that can reach three times the amount of the contravention. The varying regulations in SEA such as Malaysia's anti-money laundering laws under AMLATFPUAA put founders at risk of incurring fines or facing deal halts. Scattered regulations (like RBI circulars and OJK directives) create opportunities for "foot faults," such as unreported remittances.
• Operational and Financial Covenants: In contrast to the minimalist approach in the U.S., regional agreements impose restrictions on hiring C-suite executives, entering new markets, or incurring debt. Financial metrics (for example, maintaining a debt-to-equity ratio of less than 2:1) limit flexibility, potentially hindering necessary pivots. Any breaches lead to defaults, accelerating repayment demands during periods of cash scarcity.
• Dilution and Cap Table Complexity: Low valuations ($2-5 million) result in 2-3x effective discounts of in competitive funding rounds, slashing founder ownership. The accumulation of various notes complicates cap tables, causing concern among investors in priced rounds. India's valuation regulations introduce additional challenges if market downturns compel below-cap conversions.
• Tax Implications: The deductibility of interest benefits start-ups in India (with Section 47(x) exempting conversion gains), yet investor taxes (Section 56 on premiums) could increase overall costs. Withholding taxes in SEA (up to 20%) diminish proceeds when treaties are absent.
• Maturity and Conversion Risks: Unmet maturity dates compel repayments or lead to discounted equity sales, negatively affecting morale. Ambiguous definitions of "qualified" terms create risks of non-triggers, leaving notes stranded as debt during downturns compounded by the tighter conditions in 2024 (shorter maturities and increased rates).

Best Practices with Us

Founders should engage experienced cross-border legal advisors early for template evaluations such as adapting KISS for Southeast Asia while ensuring compliance with Indian regulations. Negotiating flexible covenants (for instance, "material adverse effect" conditions) and preferring majority amendments over unanimous consent can help preserve agility. Setting realistic caps (2–3x previous valuation) and limiting tranches to five supports a clear cap table. Financial modelling tools should be utilised to simulate scenarios and stress-test potential dilutions. In India, eligibility under automatic routes and timely submissions remain critical, in Southeast Asia, Singapore's hubs offer cohesive structuring opportunities. Monitoring regulatory updates such as quarterly RBI changes and fostering strong investor relationships helps secure extensions where needed. Convertible notes significantly empower start-ups in Southeast Asia and India, but region-specific investor biases require careful navigation. At our firm, we regularly advise on such cross-border matters, helping founders address covenants, regulations, and tax pitfalls to transform risks into growth opportunities. Convertible notes should be seen as equity-lite precursors: thorough diligence today ensures scalability for tomorrow. In unpredictable markets, informed negotiation is not just advisable, it is rather fundamental.

Footnotes

1 Rule 2- Companies (Acceptance of Deposits) Rules, 2014 | Companies Act Integrated Ready Reckoner|Companies Act 2013|CAIRR. (n.d.).

2 Taxmann. (n.d.). https://www.taxmann.com.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.