External Commercial Borrowings Facility for Startups

30 March 2021 • Kirti Arora


External Commercial Borrowings Facility for Startups

30 March 2021 • Kirti Arora

As per the report by consulting firm HexGn, Indian startups, which includes Zomato, Byjiu’s, Phonepe, Unacademy etc are estimated to have received more than USD 10 billion in funding across more than 1,200 deals in 2020 despite the COVID crisis.

An innovative idea needs to be backed by sufficient funding before it can set for a ride to explore it’s worth. It is extremely important for startups to find a proper funding prospect “outside the boundaries too” for their ventures.

The Government of India has broadened the avenues of funding for startups by opening the doors of debt financing from foreign sources via the introduction of “External Commercial Borrowings facility for startups”.

External Commercial Borrowings for startups

Reserve Bank of India permitted Startups to raise External Commercial Borrowings (ECB) with the introduction of new guidelines vide its circular dated 16th January, 2019. Pursuant to the said guidelines AD Category-I Banks are permitted to allow recognized Startups to raise ECB under the automatic route. Summarized below are the provisions:

Sr No. Particulars Explanation
1. Eligibility Criteria

An entity which is recognized as Startup by the Department for Promotion of Industry and Internal Trade (DPIIT) can raise ECB, under the specified framework for startups with liberalized norms.

Startups which do not meet the eligibility criteria but are eligible to receive Foreign Direct Investment (FDI)*, can still raise ECB, but only under the general ECB framework (i.e. no benefits as set out under specific framework for startups shall be accorded).

*A private company incorporated under the Companies Act, 2013 and identified under G.S.R. 501 (E), dated the 23rd May, 2017 issued by the Department of Industrial Policy and Promotion, Ministry of Commerce and Industry shall be considered as eligible startup to raise FDI by issuance of convertible note in terms with the Foreign Exchange Management (Non-debt Instruments) Rules, 2019.

Crux: Every Start-up which is eligible to receive FDI can avail ECB. However, in order to raise ECB under the specific framework for startups and avail benefits, a startup must be a recognized startup with the Central Government.

Rationale: This seems to be a step to encourage entities to register itself as recognized startup in order to avail the benefits accorded to a recognized startup and then to regulate those startups. The objective is to reduce the regulatory burden on Startups thereby allowing them to focus on their core business and keep compliance cost low.

Also, to create a database of startups and to analyze such data which would help the Government to form norms and policies for the benefit of startups for nurturing them better during this incubation period.

As on 15th March, 2021, 38,756 startups are registered as recognized startups with the Central Government. Click here to check the status of your startup or to register your entity as a recognized startup.

2. Maturity

ECB can be raised with the minimum average maturity period of 3 years.

Rationale: Cross-border lending without any restriction on maturity period though may appear attractive for Indian Startups but may lead to stability implications. Thus, the restriction in the form of maturity period.

3. Recognised lender

Lender should be a resident of a Financial Action Task Force (FATF) compliant country.

In order to mitigate the problem of money laundering, the lender who is the resident of FATF compliant jurisdiction shall only be recognized as a lender under ECB. Since FATF is under legal obligations to share information and cooperate with the Indian authorities in the event of any investigation.

Further, the Government intends to exclude foreign lenders who have any Indian interest from the definition of recognised lenders and also to ensure that Indian banks are not exposed to exchange rate risk. Thus, foreign branches, subsidiaries of Indian banks and overseas entity in which Indian entity has made overseas direct investment shall not fall under the purview the recognized lenders.

4. Methods for Borrowing

The borrowing can be in the form of loans or non-convertible, optionally convertible or partially convertible preference shares.

5. Currency

The borrowing should be denominated in any freely convertible currency or in Indian Rupees (INR) or a combination thereof.

The choice is left with the buyer to determine the currency denomination keeping in mind his preference towards currency exposure risk.

6. Amount

Amount of ECB to be borrowed is limited to USD 3 million or equivalent for every startup per financial year.

Rationale: To alleviate volatility and uncertainty in ECB inflows, a “soft-cap” on ECB inflows in a year is set by the Government.

7. All-in-cost

All-in-cost can be mutually agreed between the borrower and the lender.

Rationale: Since cost of borrowing is a matter of contractual relationship between the borrower and the lender. Thus, they must have the contractual freedom to determine the borrowing cost depending on the market forces and is allowed as a special relaxation for the startups as otherwise under general ECB framework, limitation on borrowing cost in terms of all-in-cost ceiling is there to regulate capital inflows and to keep the rates at par with the domestic market (else it may lead to market instability).

8. End Uses

For any expenditure related or in connection with the business of startup. Please do note that under general ECB framework, there’s a negative list for which ECB proceeds can’t be used like general corporate purpose unless it’s from foreign equity holder.

9. Conversion into Equity

Conversion into equity shares is permitted subject to RBI regulations on foreign investment in startups as specified under Foreign Exchange Management (Non-debt Instruments) Rules, 2019. However, the manner of conversion shall be governed by general ECB framework.

10. Security The decision to provide security for the borrowing to the lender is left to the borrower provided:

    • Security so provided should be in the nature of movable, immovable, intangible assets (including patents, intellectual property rights), financial securities, etc.;

    • should comply with foreign direct investment / foreign portfolio investment / or any other norms applicable for foreign lenders/entities holding such securities;

Further, issuance of corporate or personal guarantee against the ECB so borrowed is also allowed. Such guarantee can also be provided by a non-resident only if such non-resident qualifies as a lender under ECB for startups.

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.

11. Hedging

When an entity undertakes foreign currency borrowing, it exposes itself to exchange rate fluctuations risk. Thus, it is preferable (not mandatory) for startups raising ECB in foreign currency to hedge its risk either through natural hedge (i.e. by netting its economic exposure with the optimum combination of borrowing and lending) or using financial derivatives (currency futures, currency options, etc.). It is advisable for startups to ensure that they have an appropriate risk management policy to manage potential risk arising out of ECB.

If the option to hedge is not made available to the entities there is a possibility of failure of entities in case of large exchange rate movement, which in turn can hamper its investment and country’s Gross Domestic Product.

In case of INR denominated ECB, the overseas lender is also eligible to hedge its INR exposure through permitted derivative product with AD Category-1 banks.

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.

12. Conversion Rate

If borrowed in INR: the conversion rate shall be the market rate as on the date of agreement.

13. Other Provisions

Other provisions like parking of ECB proceeds, reporting arrangements, powers delegated to AD banks, borrowing by entities under investigation, conversion of ECB into equity shall be same as per general ECB framework.

However, provisions on leverage ratio and ECB liability: Equity ratio are not applicable on startups.

You can read about ECB reporting requirements and other provisions on our other blogs:

The idea of the Government is to provide an effective option to the startups to borrow funds from foreign sources with a fair number of relaxations while keeping some restrictions in place to safeguard them against volatility.

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