Convertible Notes and CCPS: How Indian Startups Actually Raise Money

Ask a founder how their seed round was structured, and 'plain equity shares' is rarely the full answer. Most early Indian startup rounds run through one of two instruments built specifically to let a founder raise money before both sides are ready to agree on a company's exact valuation: convertible notes and Compulsorily Convertible Preference Shares. Neither is exotic once you see how they actually work, and neither should be signed without understanding what it commits the company to later.

Why founders and investors reach for these instruments instead of plain equity

Pricing a very early stage company is genuinely hard. There may be no revenue, no comparable transaction, and only a founder's own projections to go on, so agreeing a per share price at the seed stage can turn into a drawn out negotiation neither side is well equipped to win. Convertible instruments sidestep that problem. The investor puts in money now, and the actual price per share gets fixed later, usually by reference to the valuation set in the startup's next priced round. This lets a round close faster and cheaper, since it avoids a full valuation exercise and the heavier documentation a priced equity round typically needs, while still giving the investor a clear mechanism to convert into ownership once there is better information to price against.

Convertible notes: debt on paper, equity in intent

A convertible note is structured as a loan. The startup receives money and, on paper, owes it back with interest, like any debt instrument. What makes it convertible is a clause letting the note holder convert that debt into equity shares instead of being repaid in cash, typically at the next qualifying funding round, and often at a discount to the price new investors pay, or subject to a valuation cap that limits how expensive the conversion price can get for the note holder. Under the Companies Act framework for startups, a note like this can be issued with a longer repayment or conversion runway than an ordinary company would get. Where the investor is a foreign entity, the Reserve Bank of India's rules add another layer: only a DPIIT recognised startup can issue convertible notes to foreign investors, each investment tranche generally needs to meet a prescribed minimum amount, and the instrument has to convert into equity or be repaid within a fixed number of years from issuance, a window RBI has extended in the past. Founders raising from foreign investors should confirm the current limit rather than rely on an older term sheet template.

CCPS: the instrument most priced rounds actually use

Once a startup moves into a properly priced round, whether that is seed, Series A, or later, the investment usually does not take the form of ordinary equity shares either. It takes the form of Compulsorily Convertible Preference Shares, or CCPS: preference shares that carry contractual protections an investor wants, such as a liquidation preference, anti dilution protection, and sometimes a preferential dividend, but which are required to convert into ordinary equity shares within a specified period rather than remaining preference shares indefinitely. That compulsory, unconditional conversion feature is exactly why regulators treat CCPS as equity for foreign investment purposes, even though it carries preference share features while it exists in its unconverted form. For founders, the practical effect is that a CCPS investor sits ahead of ordinary shareholders in a liquidation or exit, and often holds veto rights over specific company decisions, spelled out in the shareholders' agreement, well before their shares convert into plain equity.

Tax and compliance basics founders should not skip

• Valuation and angel tax exposure: shares, including CCPS, issued above fair market value can attract tax on the excess in the company's hands under Section 56(2)(viib), unless the startup holds a valid DPIIT angel tax exemption. Convertible notes are structured as debt, so this specific provision does not apply to the note itself, but it applies once conversion happens and shares are actually allotted.
• FEMA reporting: any allotment to a foreign investor, whether that is CCPS at issuance or shares issued on conversion of a note, needs to be reported to the RBI through the standard foreign investment reporting filing within the prescribed timeline, and the pricing has to respect FEMA's valuation floor for share issuance to non-residents.
• Companies Act filings: issuing either instrument typically involves a board resolution, often a special resolution and shareholder approval depending on the terms, a return of allotment filed with the Registrar of Companies, and updates to the company's statutory registers. None of this should be left until the next round's due diligence turns it up as missing.
• Stamp duty: both instruments attract stamp duty on issuance, and again on any transfer or conversion, at rates that vary by state. It is worth confirming the applicable rate in the state where the company is registered rather than assuming a flat national figure.
• Conversion mechanics belong in writing, in full detail: the discount, valuation cap, conversion trigger, and what happens if no qualifying round ever occurs should all be spelled out in the note or the share subscription agreement. Ambiguity here is one of the more common sources of dispute between founders and early investors.

Neither instrument is something a founder should adapt from a template found online without a professional actually reviewing the specific terms, because the fine print, the discount percentage, the valuation cap, the conversion triggers, the protective provisions, is where the real economics of the round sit. Understanding the basic shape of a convertible note versus CCPS is what lets a founder ask sharper questions during that review, instead of simply signing whatever the investor's lawyer sends over first.