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A start-up is considered as a business at the inception stage. The Department for Promotion of Industry and Internal Trade (DIPP) has classified the meaning of a start-up. The following are the requirements for a start-up:
From the inception period of the business to the current phase, if the operations of the business are less than ten years, then it is considered a start-up. Apart from this, the turnover from the time of formation is considered for the definition of a start-up. If the turnover is more than a hundred crore from the time of formation, then the business is called a start-up. The business activities of the start-up should be mainly for innovation, digitization, and commercialization. Previously the meaning of start-up was defined as an entity which has the following:
For this, the DIPP amended the provisions related to a start-up. This was relaxed because foreign financing could be increased for start-ups.
For an entrepreneur to commence a start-up, there is a requirement of having a business plan in place for securing finance. The various sources of finance are:
External Commercial Borrowings, also known as ECB, in short, are loans that are borrowed from foreign banks and institutions. As the name indicates, External Commercial Borrowings are borrowings that are made from international institutions and banks. ECB can only be used for a specific purpose. Many start-ups consider this option of using External Commercial borrowings for loan financing. When a company uses ECB instruments, particular criteria have to be met. The following are the requirements for external commercial borrowings:
Based on the need of the borrower, the external commercial borrowing will be issued with a maturity period. However, there will be a clause regarding the particular end-use requirement of external commercial borrowing. End-use means the primary purpose of the instrument.
The use of external commercial borrowings is regulated by the Ministry of External Affairs, the RBI, and the Department of Finance. There are a lot of compliance requirements with the use of external commercial borrowings; hence the government has relaxed the norms for the usage of ECBs by start-ups.
External commercial borrowings can be in the form of the following:
Apart from the above, ECBs can also be issued in Rupee Denominated instruments.
The RBI in a notification (“previous framework”) issued in 2016 relaxed the norms regarding the requirement of external commercial borrowing for start-ups. This was introduced as there was a need for start-ups to access foreign funds apart from the domestic investment. This notification allowed start-ups to obtain funds by way of external commercial bonds from international lenders.
For the external commercial borrowing requirement by start-ups, there are three tracks of investment. These tracks also specify the amount of maturity period for the amount of minimum investment.
A start-up under this framework can borrow up to USD 3 Million per million in the form of Foreign Currency or Indian Currency or a combination of both the denominations. The maturity period for ECBs related to start-ups is three years. The end use of the ECB instruments was based on the requirement of the start-up. Monitoring and compliance related to these forms of ECB were carried out by the Authorised Dealer and the RBI.
Through this notification, the RBI has relaxed the requirement for ECBs related to start-ups. This is due to the condition that start-ups would get the maximum value that is derived from the ECB.
Also, Read: External Commercial Borrowing for Startup.
In the new notification (“Current Framework”) that was issued in January 2019, the RBI considered the norms related to further relaxation of rules about borrowings made by a start-up when it comes to ECB. In this view, the RBI found the financing requirement of foreign investors and venture capitalists. For using the benefits of the current framework, the business has to be a startup.
In this current framework, the Foreign Exchange Management (Borrowing and Lending) Regulations, 2018 considered both borrowing and lending requirements of Indian rupees and foreign currency would come under the purview of a single head. The current framework also allowed ECB borrowings to be carried out in both Indian Rupees and Foreign Currencies. This requirement was present in the previous framework. The MAMP requirement has been kept at three years for the current framework.
In the previous framework, there were three separate tracks for ECB. The tracks had different requirements related to the amount of maturity period for each ECB. These forms of ECB accepted Indian currency and foreign currency denominations. These types of ECB were given based on the term of the loan. In the current framework related to ECB, there are two tracks for the forms of ECB. The type of ECB is just dependent on the denomination of the currency. Whether the ECB is a foreign currency-denominated or Indian currency denominated, the ECBs are categorized accordingly. The tracks are not categorized based on the term of the loan and the maturity period of the ECB. The tracks in the current framework are just dependent upon the denomination of the currency.
Apart from the above changes related to the track in the current framework, the RBI has considered making changes in the meaning of eligible borrowers and lenders. In the previous framework, the eligibility criterion for borrowers was based on the end-use requirement of the ECB and the industry. So if a borrower was considering the previous framework, then only if they were in a specific sector or industry, then the ECB could be utilized. In view of this requirement, the use of ECB was limited for many start-ups. Start-ups are into areas related to digitization and innovation; hence the RBI has considered relaxing the requirement in the current framework. The current framework allows any business which is eligible for borrowing ECB under the framework. This has removed the hurdle to innovation start-ups for securing ECB.
The current framework also enhanced the meaning of the list of eligible lenders.
The previous framework required the lender to be classified as a foreign bank, export credit institutions, and multilateral finance institutions. Because of this, the current framework has provided a clear and concise definition related to eligible lenders. The previous framework restricted several institutions from lending External Commercial Borrowings.
By the above requirement, if a venture capitalist or a private investor is a foreign equity holder, then they would only be eligible to provide loans. The current framework has changed the meaning regarding a lender and allows venture capitalists to provide loans through the ECB route for start-ups.
According to the current framework, foreign borrowing can be in the form of convertible/non-convertible preference shares or even in the form of loans. In the current framework, the amount of borrowing is limited to USD 3 Million. This amount is similar to the previous framework.
Security requirements related to the loan when borrowing an ECB are at the discretion of the borrower. Many forms of security can be provided against the loan requirement. Under the requirement of security, a personal or corporate guarantee can also be issued.
The meaning of all-in cost regulation has been discussed in the ECB framework, which states that the borrower cannot use the ECB for the repaying the interest on the loan. The requirement of all-in cost regulations could be negotiated or mutually decided between the borrower and lender. This requirement for the all-in cost is the same between the current framework and the previous framework.
Based on the above differences of the frameworks related to External Commercial Borrowings, the current framework has relaxed the norms for borrowings related to ECB. This has made start-ups use ECB for foreign loans.
Previously external commercial borrowings were significantly used as foreign financing for business purposes. After the notification, issued in 2016 by the RBI, it has allowed startups to use borrowings in the form of ECB. The 2019 notification issued by the RBI has considerably improved the framework related to External Commercial borrowings made by a Start-up. One of the main changes is the reduction of tracks for ECB based on the denomination. Also added to this the meaning of eligible lenders and eligible borrowers have been more clear and precise. Apart from the above significant changes, there are other differences between the two notifications. By doing this, the RBI has significantly relaxed the norms related to ECB borrowings by a start-up.
See Our Recommendation: External Commercial Borrowing (ECB) Regulations.