Legal Standpoint of iSAFE Instruments in India

Understanding iSAFE Instruments

iSAFE (Indian Simple Agreement for Future Equity) instruments are the Indian equivalent of the widely used SAFE (Simple Agreement for Future Equity) instruments in the United States. These agreements are used typically between a company and its investors, grant the right to acquire equity at a later stage.

SAFENotes are a type of convertible security that allows startups to raise funds from Investors without giving up equity or setting a valuation of their company. As an adaptation of SAFE Notes in India, iSAFE Notes were first introduced by an Indian VC firm 100X.VC.

SAFE or iSAFE instruments became popular due to their simplicity and flexibility, especially for early-stage, pre-revenue companies. These instruments are convertible into equity upon the occurrence of a specified event or maturity date.

In India, the concept of iSAFE is still new and lacks recognition under any specific law. Instead, they are subject to the same regulations and laws as other securities. Any issuance of SAFENotes in India must comply with the Companies Act, 2013 which governs the issuance of securities by companies.

However, despite this lack of formal recognition, many startups are using iSAFE to raise funds because it allows them to attract investment at an early stage, even before the company’s valuation can be established.

How Can iSAFE Instruments Be Made Legally Compliant?

Since iSAFE instruments are neither convertible notes nor debt, the question arises: how can they be considered secure, from a legal standpoint?

The solution lies in the issuance of Compulsorily Convertible Preference Shares (CCPS) or Compulsorily Convertible Debentures (CCDs). To be compliant with Indian law, companies must adhere to Sections 42, 55, 62 and 71 of the Companies Act, 2013, along with the Companies (Share Capital and Debentures) Rules, 2014, and the Companies (Prospectus and Allotment of Securities) Rules, 2014.

By designating iSAFE instruments as CCPS/CCDs, companies provide investors with legal security and enforceability, ensuring compliance with Indian laws until specific guidelines for iSAFE instruments are introduced.

Pros and Cons

Pros

No dilution occurs in the cap table until the occurrence of the priced round or an early conversion.

The duration to conclude the deal is reduced by at least a few weeks, attributed to the time saved in drafting a SHA and the accompanying multiple iterations.

Since iSAFE Notes are not classified as debt, no interest accrues on iSAFE Notes.

An iSAFE note is a simple agreement. The startup will save significant money in engaging lawyers to draft detailed SHAs.

Cons

(To every advantageous thing, there are corresponding disadvantages)

There is no sense of security to both the Investors and the fundraising startup owner

iSAFENotes do not provide Investors with exit rights as the iSAFE notes gets converted in to Equity

The Investors do not get any interest on their investments. The money of the Investors is risked until a triggering event arises in the future.

Conclusion

For the Indian economy to prosper and compete with developed economies, the growth of Start-ups is mandatory. The growth of Startups depends upon the level of investments in the economy. While iSAFE instruments provide a convenient and flexible method for startups to raise early-stage funding, their lack of formal recognition under Indian law creates uncertainty. However, by issuing CCPS/CCDs in compliance with the Companies Act and relevant rules, startups can bridge this legal gap and offer investors a secure, enforceable investment option. As the Indian startup ecosystem evolves, it will be crucial for lawmakers to provide clarity and specific guidelines for the use of iSAFE instruments independently in the future.