Convertible Note vs Equity: Which Fits an Indian Startup's Early Round?

Two ways to take the same cheque

An angel offers your company ₹50 lakh. You can take the money in exchange for shares today, at a price you both agree now. Or you can take it as a convertible note, an instrument that starts life as money owed by the company and turns into shares later, usually when a larger priced round happens. The cash in the bank is the same on day one. What differs is when the price is set, what the investor's rights are in the meantime, and what happens if the expected round never arrives.

Neither route is automatically founder-friendly or investor-friendly. A note can save time when nobody can sensibly agree a valuation, but it carries legal conditions in India and can create a repayment obligation. Equity sets ownership clearly but forces a valuation discussion and a heavier set of corporate steps. This guide explains both, then works through the arithmetic so you can see how each affects your cap table. If you have not read it yet, our cap table guide explains the vocabulary used below.

What makes a convertible note legally workable in India

In India, a company receiving money that is not share capital has to consider the deposit rules under the Companies Act, 2013. The Companies (Acceptance of Deposits) Rules, 2014 define what counts as a deposit and list exclusions. One exclusion, in rule 2(1)(c)(xvii), covers an amount of twenty-five lakh rupees or more received by a start-up company by way of a convertible note, in a single tranche, from a person. The note must be convertible into equity shares or repayable within a period not exceeding ten years from issue. The ten-year period was substituted for five years by the Companies (Acceptance of Deposits) Amendment Rules, 2020.

The Explanation to that sub-clause matters just as much. It defines a start-up company as a private company recognised under the Department for Promotion of Industry and Internal Trade notification referred to there, and defines a convertible note as an instrument evidencing receipt of money initially as a debt, repayable at the holder's option or convertible into equity shares on specified events and terms.

Read together, the practical conditions are these:

• The company is a private company with DPIIT start-up recognition.
• Each note is at least ₹25 lakh, received in a single tranche, from one person.
• The note converts into equity or is repayable within ten years.

A ₹10 lakh note from a friend, or a note issued by a company without recognition, does not fit that exclusion. If money received does not fit an exclusion, the company risks having accepted a deposit, which brings its own restrictions and compliance. This is exactly the kind of point where a qualified company secretary or lawyer should confirm your position before you sign.

If the investor is a person resident outside India, foreign exchange rules also apply. The Foreign Exchange Management (Non-debt Instruments) Rules, 2019 contain provisions on convertible notes issued by startups to non-residents, with their own conditions and reporting. The definition of startup in those rules was aligned to the DPIIT notification in 2024. Check eligibility, sector conditions and reporting with your authorised dealer bank and counsel before accepting foreign money on a note.

What a priced equity round involves

With equity, the company issues shares at an agreed price. For a private company this is usually done through a private placement or preferential allotment under the Companies Act, with board and shareholder approvals, a valuation where required, a separate bank account for application money in a private placement, allotment within the permitted time and a return of allotment filed with the Registrar in Form PAS-3. Many early rounds in India use compulsorily convertible preference shares rather than plain equity, because they allow investor protections such as liquidation preference while still converting to equity later.

The heavier process has a benefit. Once shares are allotted, ownership is fixed. The investor is a shareholder with the rights in your articles and shareholders' agreement, and there is no debt on the balance sheet. The cost is time, legal fees and the need to agree a valuation now. For how to read the rights attached to that valuation, see our guide on how to evaluate a term sheet.

How investors think about each option

An angel choosing between the two is weighing risk and reward over the same uncertain period. A note usually gives the investor two ways to be rewarded for going early. A valuation cap sets the maximum company value at which the note will convert, and a discount lets the note convert at a percentage below the next round's price. Some notes also carry interest that accrues and converts. The investor's worry is that the next round may take longer than planned, or may never happen, and that as a creditor they have fewer governance rights than a shareholder in the meantime.

With equity, the investor knows exactly what they own and has shareholder rights from day one. The investor's worry here is paying too high a price before the company has proved much. Experienced angels often accept notes for small, fast bridge amounts and prefer equity or preference shares for larger cheques where they want information rights and a board seat or observer.

For founders, the useful move is to ask the investor what they are really worried about, then choose the instrument that addresses it. A dispute over valuation can sometimes be solved with a cap. A demand for control will not be solved by changing instruments.

Worked example: ₹50 lakh as a note or as equity

This example is hypothetical and simplified. Assume a DPIIT-recognised private company with 10,00,000 fully diluted shares held by founders. An angel invests ₹50 lakh. About a year later, a fund leads a ₹3 crore round at a ₹12 crore pre-money valuation. We ignore interest, option pools and legal nuances in cap definitions so the logic stays visible.

Option A: convertible note with a ₹8 crore valuation cap and a 20% discount, converting at whichever gives the lower price.

• Round price: ₹12 crore ÷ 10,00,000 = ₹120 per share.
• Discount price: ₹120 × 80% = ₹96.
• Cap price: ₹8 crore ÷ 10,00,000 = ₹80. The cap gives the lower price, so the note converts at ₹80.
• Note shares: ₹50,00,000 ÷ ₹80 = 62,500.
• Fund shares: ₹3,00,00,000 ÷ ₹120 = 2,50,000.

Option B: equity today at an ₹8 crore pre-money valuation.

• Price: ₹8 crore ÷ 10,00,000 = ₹80. Angel shares: 62,500.
• At the later round, the ₹12 crore pre-money now spreads across 10,62,500 shares, so the price is about ₹112.94.
• Fund shares: ₹3 crore ÷ (₹12 crore ÷ 10,62,500) = 2,65,625.

The difference is small here, and it comes almost entirely from one assumption: whether the fund's pre-money valuation includes the angel's shares. In Option A we assumed the note converts on top of the ₹12 crore pre-money; in Option B the angel's shares are already inside it. Real term sheets decide this explicitly, and a fund may insist the note converts inside its pre-money, which would shift dilution back onto founders. That drafting point often matters more than the choice of instrument itself.

Now change one fact. The fund round does not happen, and the company is growing slowly on revenue. Under Option B, nothing changes: the angel is a shareholder. Under Option A, the note stays outstanding. If its terms let the holder demand repayment at maturity, the company needs ₹50 lakh of cash it may not have. That is the real risk of a note, and it is why maturity, repayment and default terms deserve as much attention as the cap.

Terms to negotiate in a note

• Valuation cap: the ceiling on conversion value. Agree whether it is measured pre-money or post-money and whether it includes the note itself.
• Discount: the reduction to the next round price, if any.
• Qualified financing: the size and type of round that triggers automatic conversion.
• Maturity and what happens then: conversion at the cap, extension, or repayment at the holder's option. Keep within the ten-year limit in the deposit rules.
• Interest: whether it accrues and converts, and any tax treatment your chartered accountant flags.
• Sale of the company before conversion: whether the holder gets a multiple of principal or converts at the cap.
• Information rights: what updates the holder receives while the note is outstanding.

When each option tends to fit

A convertible note tends to fit when the company is DPIIT-recognised, each cheque is at least ₹25 lakh, the next priced round is realistically near, and both sides want to avoid negotiating a valuation on thin evidence. It is also common as a bridge between two priced rounds.

Equity or compulsorily convertible preference shares tend to fit when the company does not meet the note conditions, when cheques are smaller than ₹25 lakh each, when investors want governance rights now, or when a priced round is not expected soon and nobody wants a debt instrument hanging over the company. It is also cleaner when many small investors are involved.

Whichever you choose, model the round in a spreadsheet before signing, including the next round. Our guide to pre-money vs post-money valuation explains why the inclusion question in the example above changes outcomes.

Founder decision checklist

• Confirm the company is a private company with DPIIT recognition before considering a note.
• Check each proposed note is at least ₹25 lakh, from one person, in a single tranche.
• For any non-resident investor, check foreign exchange conditions with your bank and counsel.
• Model conversion under the cap and discount at two or three plausible next-round valuations.
• Write down, in plain words, what happens if no priced round occurs by maturity.
• Agree how the note sits relative to the next investor's pre-money valuation.
• Ask your chartered accountant about tax and accounting treatment.
• Have qualified Indian counsel draft or review the instrument; do not adapt a foreign template as is.

Take the next step

If you are preparing an early round and want investor-ready materials, you can apply as a founder to RaiseMoney. Applying does not guarantee introductions or investment.

Educational disclaimer

This article is general education, not legal, tax or investment advice. Rules and their interpretation change and depend on your facts. Consult a qualified Indian lawyer, company secretary and chartered accountant before issuing any instrument.

Sources

Sources reviewed 24 September 2026.

• India Code: The Companies Act, 2013
• Companies (Acceptance of Deposits) Rules, 2014, consolidated with amendment notifications (Government of India gazette text)
• Ministry of Corporate Affairs
• Foreign Exchange Management (Non-debt Instruments) Rules, 2019 (Government of India text)
• Startup India: DPIIT startup recognition

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