3. Funding Instruments Deep Dive¶

3.1 Executive Summary¶

• Equity financing (common and preferred stock) gives investors ownership and board representation but dilutes founders permanently, making it appropriate for growth capital but expensive for working capital
• Convertible notes and SAFEs defer valuation until the next priced round, with conversion mechanics including valuation cap (20-50% discount to Series A) and discount rate (15-25%), enabling faster closes for pre-seed and seed rounds
• Compulsorily Convertible Preference Shares (CCPS) are India's preferred instrument for institutional funding, providing liquidation preference (1x non-participating standard), anti-dilution protection, and mandatory conversion to equity after predetermined period
• Revenue-based financing and venture debt provide non-dilutive capital for revenue-generating companies, with monthly repayment of 2-8% of revenue until 1.3-2.0x multiple repaid, but require consistent cash flow and are 50-100% more expensive than equity on IRR basis
• SAFE vs convertible note choice depends on simplicity preference (SAFE has no maturity or interest) vs investor protection needs (note provides debt fallback if company fails to raise priced round), with Indian legal framework better supporting notes through established debt enforcement mechanisms

3.2 Understanding Your Funding Options¶

Every funding instrument represents a different trade-off between control, dilution, cost of capital, and flexibility. Founders often default to equity financing without considering alternatives better suited to their situation. A SaaS company with $500K ARR raising $2M for growth might choose revenue-based financing, avoiding 20-30% dilution while paying 2-4% of monthly revenue until $2.6M repaid (1.3x multiple). A pre-revenue AI startup needs equity capital from investors willing to wait 7-10 years for returns.

This chapter breaks down each instrument's mechanics, economics, advantages, disadvantages, and appropriate use cases. Mastering these options enables founders to structure deals that maximize strategic value while minimizing unnecessary dilution and cost.

3.3 Equity Financing: Common and Preferred Stock¶

Common Stock Structure¶

Common stock represents basic ownership with voting rights, dividend rights (if declared), and residual claim on assets after debt and preferred stock in liquidation. Founders, employees, and advisors typically hold common stock.

Key Characteristics:

• Voting Rights: One vote per share (or as specified in Articles of Association)
• Dividend Rights: Right to receive dividends if and when declared by board
• Liquidation Rights: Residual claim after all debt and preferred stock preferences satisfied
• Conversion: N/A—already lowest in capital structure
• Redemption: Generally non-redeemable (except through buyback provisions)

Advantages for Founders:

• Simple capital structure in early stages
• No liquidation preference overhang
• All shareholders treated equally

Disadvantages for Founders:

• Lacks protection features investors demand
• Difficult to raise institutional capital using only common stock
• Founders face maximum dilution risk in down rounds

Preferred Stock Mechanics¶

Preferred stock sits above common stock in the capital structure, providing investors with downside protection through liquidation preferences while maintaining upside through conversion to common stock.

Standard Preferred Stock Features:

1. Liquidation Preference: Right to receive investment amount (or multiple) before common stockholders receive anything. Standard is 1x non-participating (Chapter 7: Term Sheet Analysis covers variants in detail).

2. Conversion Rights: Preferred converts to common stock at holder's option, typically 1:1 ratio initially. Investors convert when pro-rata common ownership is worth more than liquidation preference.

3. Anti-Dilution Protection: Adjusts conversion price downward if company raises subsequent rounds at lower valuations (Chapter 11: Dark Patterns - Predatory Terms to Avoid covers mechanics).

4. Dividend Rights: Preferential dividend rights over common stock, either:

5. Cumulative: Accrues annually whether or not declared, must be paid before any common dividends
6. Non-Cumulative: Only paid if declared by board
7. Participating: Gets preferred dividend PLUS pro-rata common dividend

Most early-stage preferred stock has non-cumulative, non-participating dividend rights at 6-8% annually, rarely declared.

1. Voting Rights: Typically votes alongside common stock on as-converted basis (1:1). May have separate class voting rights on specific matters (sale of company, amendments to preferred rights, issuance of senior securities).

2. Board Representation: Often includes right to appoint one or more board directors.

3. Information Rights: Quarterly financial statements, annual audited financials, annual budget.

4. Protective Provisions: Veto rights over major decisions including increasing authorized shares, creating senior securities, selling company, declaring dividends, amending Articles of Association.

Example 1: Series A Preferred Stock Term Summary

Instrument: Series A Preferred Stock
Investment: $5,000,000
Shares Issued: 2,500,000
Price Per Share: $2.00
Liquidation Preference: 1x, non-participating
Dividend: 8% cumulative preferred, non-participating
Conversion: Initially 1:1, adjusts for stock splits/dividends
Anti-Dilution: Broad-based weighted average
Voting: As-converted basis plus class votes on specified matters
Board Seats: 1 of 5 seats
Protective Provisions: Standard (senior securities, sale, charter amendments)

Compulsorily Convertible Preference Shares (CCPS): India's Preferred Instrument¶

CCPS represents the Indian adaptation of convertible preferred stock, designed to comply with Section 55 of the Companies Act 2013, which requires all preference shares to be redeemed within 20 years. By making conversion mandatory (compulsory) at a future date or event, CCPS avoids redemption requirements while providing investors with preferred stock benefits.

Structural Mechanics:

1. Compulsory Conversion Trigger: Conversion happens automatically upon occurrence of specified event:
2. Specific date (e.g., 7 years from issuance)
3. Qualified IPO (listing on recognized stock exchange)
4. Liquidation event (acquisition, merger)

5. Series B or later funding round (converts immediately before next round)

6. Conversion Ratio: Specifies how many common shares each CCPS converts into

Initial Conversion Ratio = 1:1 (one CCPS converts to one common share)
Adjusted by: Stock splits, stock dividends, anti-dilution provisions

1. Liquidation Preference: 1x to 2x investment amount, non-participating is standard for seed/Series A

If 1x preference: Investor receives $5M OR pro-rata share, whichever is greater
If 2x preference: Investor receives $10M OR pro-rata share, whichever is greater

1. Cumulative Dividends: Typically 0.001% to 1% per annum, cumulative but not paid (accrues to liquidation preference)

Annual Dividend = Investment Amount × Dividend Rate
This increases liquidation preference annually if cumulative

Example 2: CCPS Structure for $3M Series A

Instrument: Series A CCPS
Investment: ₹24,00,00,000 ($3M at ₹80/USD)
Shares Issued: 1,200,000 CCPS
Issue Price: ₹2,000 per share
Face Value: ₹10 per share (remainder is premium)
Liquidation Preference: 1x non-participating
Dividend: 0.001% cumulative preferred
Conversion: Compulsory upon (i) IPO, (ii) 7 years, or (iii) Series B round
Conversion Ratio: 1:1 initially, subject to anti-dilution
Anti-Dilution: Broad-based weighted average
Voting: Pari passu with common on as-converted basis
Board Seats: 1 of 5

At Liquidation (Before Conversion):

• Series A has 1x liquidation preference = ₹24 crore
• If company sells for ₹100 crore:
• Series A receives ₹24 crore (preference), leaving ₹76 crore
• Compare to pro-rata: 1.2M / 10M total shares = 12% × ₹100 crore = ₹12 crore
• ₹24 crore > ₹12 crore, so Series A takes preference
• If company sells for ₹400 crore:
• Series A preference: ₹24 crore
• Series A pro-rata: 12% × ₹400 crore = ₹48 crore
• ₹48 crore > ₹24 crore, so Series A CONVERTS and takes ₹48 crore

Advantages of CCPS:

• Complies with Indian Companies Act Section 55 (20-year redemption requirement)
• Provides investor downside protection through liquidation preference
• Maintains investor upside through compulsory conversion
• Enables complex capital structures with multiple series (A, B, C with different preferences)
• Well-understood by Indian lawyers, CAs, and VCs

Disadvantages of CCPS:

• More complex than common stock (requires SHA specifying all terms)
• Compulsory conversion may trigger tax events
• Premium over face value creates accounting complexity
• Less familiar to international investors accustomed to US-style preferred stock

Funding Instruments: Key Differences¶

Equity Financing Use Cases¶

When to Use Equity:

• Pre-revenue or minimal revenue ($0-$500K ARR) where debt repayment impossible
• High-growth capital needs exceeding near-term cash generation capacity
• Strategic investors bringing value beyond capital (distribution, technology, brand)
• Patient capital for 7-10 year build timeline
• Building toward eventual IPO or strategic acquisition

When to Avoid Equity:

• Working capital needs for revenue-generating business (use debt or RBF)
• Short-term capital needs (<12 months) with clear revenue visibility
• Founders unwilling to accept dilution and board involvement
• Company already raised many equity rounds and cap table is diluted

3.4 Convertible Notes and SAFEs¶

Convertible Note Mechanics¶

Convertible notes are debt instruments that convert into equity (typically preferred stock) at a future financing round. They defer valuation while providing immediate capital.

Key Terms:

1. Principal Amount: The loan amount
2. Interest Rate: Typically 4-8% annually, accrues and converts with principal
3. Maturity Date: Date by which note must be repaid or converted (18-24 months standard)
4. Valuation Cap: Maximum valuation at which note converts
5. Discount Rate: Percentage discount to next round price (15-25% standard)
6. Conversion Trigger: Qualified financing (typically $1M+ priced equity round)

Conversion Mechanics:

When a qualified financing occurs, the note converts using the LOWER of:

• (Investment + Accrued Interest) / (Valuation Cap / Fully Diluted Shares), OR
• (Investment + Accrued Interest) / (Series A Price × (1 - Discount Rate))

Example 3: Convertible Note Conversion

Note Terms:
- Principal: $500,000
- Interest: 6% annually
- Maturity: 24 months
- Valuation Cap: $8,000,000
- Discount: 20%
- Issued: January 1, 2023

Series A Terms (January 1, 2024 - 12 months later):
- Investment: $5,000,000
- Pre-Money Valuation: $20,000,000
- Post-Money Valuation: $25,000,000
- Price Per Share: $2.50
- Pre-Money Shares: 8,000,000

Step 1: Calculate accrued interest

Interest = $500,000 × 6% × 1 year = $30,000
Total to Convert = $500,000 + $30,000 = $530,000

Step 2: Calculate conversion prices

Valuation Cap Price:

Cap Price = Valuation Cap / Pre-Money Shares
Cap Price = $8,000,000 / 8,000,000 = $1.00 per share

Discount Price:

Discount Price = Series A Price × (1 - Discount Rate)
Discount Price = $2.50 × (1 - 0.20) = $2.00 per share

Step 3: Choose lower price (better for investor)

$1.00 < $2.00, so use Cap Price of $1.00

Step 4: Calculate shares issued

Shares from Note = $530,000 / $1.00 = 530,000 shares

Step 5: Verify ownership percentage

Post-Note Shares = 8,000,000 (pre-money) + 2,000,000 (Series A) + 530,000 (note) = 10,530,000
Note Ownership = 530,000 / 10,530,000 = 5.0%
Series A Ownership = 2,000,000 / 10,530,000 = 19.0%
Founder Ownership = 8,000,000 / 10,530,000 = 76.0%

Note Holder's Effective Price: $530,000 / 530,000 shares = $1.00 per share (60% discount to Series A's $2.50)

Series A Investor Analysis:

Series A investor pays $2.50 per share for 19% ownership
Note holder paid effectively $1.00 per share (through cap) for 5% ownership
Note holder got 2.5x better price per percentage point of ownership

Advantages of Convertible Notes:

• Faster Closing: No valuation negotiation, simpler documentation (3-5 pages vs 30-50 page SHA)
• Lower Legal Costs: ₹50,000-₹1.5 lakh vs ₹3-10 lakh for equity round
• Founder-Friendly: No board seats, information rights, or protective provisions until conversion
• Interest Accrual: Provides additional equity value
• Debt Fallback: If company fails to raise priced round, note can be repaid (though rarely enforced)

Disadvantages of Convertible Notes:

• Maturity Pressure: Creates forcing function at maturity date
• Cap Table Complexity: Future investors must model note conversion in cap table
• Valuation Cap Negotiations: Cap too low dilutes founders; cap too high makes note unattractive
• Multiple Notes: Several notes with different caps/discounts create complex cap table
• Taxation on Accrued Interest: Interest may be taxable income for investor even if not paid

SAFE (Simple Agreement for Future Equity)¶

SAFE, created by Y Combinator in 2013 and updated through multiple iterations (most recent 2018), eliminates debt characteristics while maintaining convertible note economics.

Key Differences from Convertible Notes:

SAFE Variants (Y Combinator 2018 templates):

1. Valuation Cap, No Discount: Most common for strong companies
2. Discount, No Valuation Cap: Rare, used when founders resist cap
3. Valuation Cap + Discount: Most investor-friendly, common for competitive rounds
4. MFN (Most Favored Nation), No Cap/Discount: Converts at same terms as future SAFEs; rare

Post-Money SAFE (2018 Update):

Y Combinator's 2018 SAFE update introduced "post-money" valuation cap, clarifying that SAFE holders receive their percentage AFTER accounting for all other SAFEs but BEFORE new investors.

Example 4: Post-Money SAFE Conversion

SAFE Terms:
- Investment: $500,000
- Post-Money Valuation Cap: $10,000,000
- No discount

Series A Terms:
- Investment: $5,000,000
- Pre-Money Valuation: $20,000,000

Step 1: Calculate SAFE percentage

SAFE Ownership % = Investment / Post-Money Cap
SAFE Ownership % = $500,000 / $10,000,000 = 5.0%

Step 2: Calculate total shares

Founder Shares (pre-SAFE): 10,000,000
SAFE converts, creating dilution

Let X = Total shares after SAFE conversion
SAFE Shares = 5.0% × X
Founder Shares = 95.0% × X = 10,000,000
Therefore: X = 10,000,000 / 0.95 = 10,526,316
SAFE Shares = 10,526,316 - 10,000,000 = 526,316

Step 3: Series A investment

Series A wants 20% ownership
Pre-Money Shares (including SAFE): 10,526,316
Series A Shares = (10,526,316 × 0.20) / 0.80 = 2,631,579
Post-Money Shares = 10,526,316 + 2,631,579 = 13,157,895

Step 4: Final ownership

Founders: 10,000,000 / 13,157,895 = 76.0%
SAFE: 526,316 / 13,157,895 = 4.0%
Series A: 2,631,579 / 13,157,895 = 20.0%

SAFE Holder's Effective Valuation: $500,000 / 4.0% = $12.5M post-money (received 25% discount to $20M pre-money + $5M = $25M Series A post-money)

Advantages of SAFEs:

• Simplest Instrument: 5-page document vs 30-50 page SHA
• No Maturity Pressure: Eliminates forced conversion or repayment deadline
• No Interest: Cleaner cap table math
• Founder-Friendly: Even more flexibility than notes
• Clear Conversion: Post-money SAFE eliminates ambiguity about ownership percentage

Disadvantages of SAFEs:

• Less Tested in Indian Courts: Limited case law on SAFE enforcement vs established debt law for notes
• No Investor Protections: No maturity date or interest makes SAFE holders fully dependent on future financing
• Foreign Instrument: Created for US law; Indian adaptations may have complications
• Potential Tax Uncertainty: SAFE's classification (debt vs equity) may create tax ambiguity

Convertible Instruments in Indian Context¶

RBI Treatment: Convertible notes issued to non-residents must comply with RBI regulations. The Master Direction on Foreign Investment in India (January 2025 update) specifies:

• Minimum investment: ₹25 lakh ($30,000) per foreign investor per investment
• Conversion deadline: Within 5 years from issuance
• At conversion: Equity shares must be issued at or above Fair Market Value per RBI pricing guidelines
• Interest rate: No restrictions; determined by commercial negotiation
• Transfer: Freely transferable at prices complying with pricing guidelines

FC-GPR Filing: Unlike equity investments (which require FC-GPR within 30 days of share allotment), convertible notes have unique reporting:

• At issuance: File FC-GPR reporting convertible note issuance
• At conversion: File FC-GPR reporting equity share issuance from conversion

SAFE Legal Status: SAFEs lack explicit RBI recognition and have limited precedent in Indian courts. Many Indian lawyers recommend convertible notes over SAFEs for foreign investors due to clearer regulatory treatment.

3.5 Revenue-Based Financing and Venture Debt¶

Revenue-Based Financing (RBF) Mechanics¶

RBF provides capital in exchange for a fixed percentage of monthly revenue until a predetermined multiple (typically 1.3x to 2.0x) is repaid. No equity dilution, no board seats, no personal guarantees.

Structure:

Loan Amount: $500,000
Repayment Multiple: 1.5x
Total Repayment: $750,000
Monthly Payment: 4% of gross revenue
Repayment Period: Until $750,000 paid or 5 years, whichever comes first

Example 5: RBF Repayment Schedule

Month 1:
Revenue: $100,000
Payment: $100,000 × 4% = $4,000
Remaining: $750,000 - $4,000 = $746,000

Month 2:
Revenue: $120,000
Payment: $120,000 × 4% = $4,800
Remaining: $746,000 - $4,800 = $741,200

Month 3:
Revenue: $90,000 (slower month)
Payment: $90,000 × 4% = $3,600
Remaining: $741,200 - $3,600 = $737,600

If average monthly revenue = $100,000:

Average monthly payment = $100,000 × 4% = $4,000
Months to repay = $750,000 / $4,000 = 18.75 months
Effective annual cost = ($750,000 - $500,000) / $500,000 / 1.56 years = 32.1% APR

Advantages of RBF:

• Non-Dilutive: Preserves founder ownership
• Flexible Repayment: Payments scale with revenue (slower months = lower payments)
• No Personal Guarantee: Company-level obligation only
• No Board Interference: Lender typically has no governance rights
• Faster Repayment in Good Times: High-growth months accelerate payoff

Disadvantages of RBF:

• Expensive: 30-50% effective APR vs 5-15% for equity on IRR basis
• Cash Flow Drain: Ongoing monthly payments reduce reinvestment capacity
• Revenue Requirement: Need minimum $40K-$100K monthly revenue to qualify
• Covenants: May have revenue decline triggers, minimum cash balance requirements
• Limited in India: Few India-focused RBF providers vs dozens in US

Indian RBF Providers:

• Velocity (US-based, some India exposure)
• GetVantage (India-focused, launched 2019, ₹1,000 crore+ deployed)
• Klub (India-focused, D2C brands)
• Recur Club (India-focused, SaaS and D2C)

Ideal Candidates for RBF:

• SaaS companies with $500K+ ARR and 80%+ gross margins
• D2C brands with $2M+ annual GMV and 40%+ margins
• Marketplaces taking 15-25% take rate with $5M+ annual GMV
• Companies needing growth capital but wanting to delay next equity round

Venture Debt Mechanics¶

Venture debt provides term loans (typically 2-4 years) to venture-backed startups, with repayment starting immediately or after 6-12 month interest-only period. Often includes warrants (equity upside) alongside debt.

Structure:

Loan Amount: $2,000,000
Interest Rate: 12-14% annually
Term: 36 months
Warrants: 5-10% warrant coverage (5-10% of loan amount in equity)
Repayment: 6 months interest-only, then 30 months amortization

Example 6: Venture Debt Repayment

Loan: $2,000,000
Interest: 13% annual
Warrant Coverage: 7.5% = $150,000 warrant value
Valuation for Warrants: $30M (current round valuation)
Warrant Shares: $150,000 / $3.00 per share = 50,000 shares

Months 1-6 (Interest-Only):
Monthly Interest = $2,000,000 × 13% / 12 = $21,667
Principal Balance = $2,000,000 (unchanged)

Months 7-36 (Amortization):
Monthly Payment = Principal / 30 months + Interest
Month 7: ($2,000,000 / 30) + ($2,000,000 × 13% / 12) = $66,667 + $21,667 = $88,334
Month 8: ($2,000,000 / 30) + ($1,933,333 × 13% / 12) = $66,667 + $20,945 = $87,612
... (continues with declining interest component)

Total Interest Paid: ~$450,000 over 36 months
Total Cost: $450,000 + warrant value

Effective Cost Calculation:

Cash Interest: $450,000
Warrant Dilution: 50,000 shares at $30M valuation = $150,000 current value
If company exits at $100M: 50,000 / 11M shares = 0.45% × $100M = $450,000
Total Cost: $450,000 + $450,000 (at exit) = $900,000
Effective Cost: $900,000 / $2,000,000 = 45% over 3 years = 13.2% APR

Compare to equity alternative:

Raising $2M equity at $30M post-money = 6.67% dilution
At $100M exit: 6.67% = $6,670,000
Venture debt preserved: $6,670,000 - $900,000 = $5,770,000 (86% savings)

Advantages of Venture Debt:

• Less Dilutive than Equity: 0.5-1.0% warrants vs 5-10% equity round
• Extended Runway: Bridges to next equity round or profitability
• No Valuation Negotiation: Based on most recent equity round valuation
• Faster Close: 3-4 weeks vs 3-4 months for equity
• No Board Seats: Lender typically observer rights only

Disadvantages of Venture Debt:

• Mandatory Repayment: Unlike equity, must repay regardless of business performance
• Requires Equity Backing: Most lenders require prior VC round and min 12-month runway post-loan
• Personal Guarantee: Sometimes required for small loans
• Covenants: Cash balance minimums, revenue milestones, additional equity raise requirements
• Expensive if Fail: If company struggles, debt accelerates while equity would be patient

Indian Venture Debt Providers:

• InnoVen Capital (largest, 250+ investments)
• Alteria Capital (Innoven's spin-off, 80+ investments)
• Trifecta Capital (45+ investments, focus on later-stage)
• Stride Ventures (40+ investments)

Debt Instruments: When to Use¶

Use Revenue-Based Financing When:

• Monthly revenue $50K+ with 40%+ gross margins
• Want to delay equity round 6-12 months while proving additional traction
• Growth capital needs ($500K-$2M) for scaling proven channels
• Unwilling to accept dilution for working capital

Use Venture Debt When:

• Recently closed equity round (Series A+) with 12+ month runway
• Need $2M-$10M to extend runway 9-12 months to next milestone
• Equipment financing needs (servers, inventory, hard assets)
• Want to preserve equity for strategic moment (pre-IPO, competitive Series B)

Avoid Debt When:

• Pre-revenue or <$20K monthly revenue (cannot service debt)
• Business highly unpredictable (debt creates bankruptcy risk)
• Already raised many equity rounds at declining valuations (creditors nervous)
• Near-term prospects for equity raise strong (equity likely cheaper long-term)

3.6 Instrument Comparison and Selection Framework¶

Side-by-Side Comparison¶

Decision Framework¶

Step 1: Assess Revenue and Cash Flow

Monthly Revenue < $20K → Equity (Common or CCPS) or Convertible/SAFE
Monthly Revenue $20K-$100K → Consider Convertible/SAFE, possibly equity
Monthly Revenue $100K-$500K → RBF becomes viable option
Monthly Revenue $500K+ with VC backing → Venture debt viable

Step 2: Assess Strategic Value of Investors

High strategic value (distribution, brand, expertise) → Accept equity dilution
Commodity capital (just money) → Minimize dilution via debt or convertibles

Step 3: Assess Time to Close

Need capital in <4 weeks → SAFE or convertible note only
Can wait 2-3 months → Full equity round with proper diligence

Step 4: Assess Valuation Confidence

Low confidence in valuation (pre-revenue, unclear comps) → Convertible/SAFE
High confidence in valuation (strong metrics, clear comps) → Priced equity round

Step 5: Model Dilution Scenarios

Calculate ownership at various exit values with each instrument
Choose instrument minimizing dilution while meeting capital needs

3.7 Case Studies¶

Case Study 1: Zepto - Aggressive CCPS Financing¶

Context: Zepto raised $60M seed + Series A in 2021, $100M Series B, $200M Series C (2022), $200M Series D (2023), and $340M Series E (2024) using CCPS structure across all rounds. The company exemplifies rapid scaling on equity capital.

CCPS Structure Benefits:

• Liquidation Preference Protection: Each series has 1x non-participating preference, protecting investors if exit below cumulative investment ($900M+)
• Anti-Dilution Protection: Broad-based weighted average protects against down rounds
• Conversion Flexibility: Compulsory conversion upon IPO enables clean cap table for public listing

Outcome: Valuation progression from $225M (2021) to $5B (2024) demonstrates CCPS structure didn't impede valuation growth. Founders retained ~30-35% ownership despite raising $900M+ across 5 rounds.

Lessons:

• CCPS standard for Indian VC deals works for rapid scaling
• Multiple series with different preferences create liquidation waterfall complexity (Chapter 7: Term Sheet Analysis)
• Aggressive fundraising preserved runway through uncertainty but diluted founders significantly
• Reverse flip to India (2025) demonstrates CCPS compatible with Indian IPO plans

Case Study 2: Cred - Bridge Financing with Convertible Structure¶

Context: While Cred raised primarily equity rounds, the company reportedly used convertible structures for smaller bridge rounds between major equity rounds to extend runway without full valuation negotiation.

Convertible Use Case:

• Series C closed at $2.2B valuation (October 2021)
• Company needed additional $50-100M in early 2022 as markets deteriorated
• Rather than raise full Series D at potentially lower valuation (down round), used convertible notes/SAFE with $2.5B cap
• When Series D eventually closed (2023), convertibles converted at favorable terms

Outcome: Avoided down round optics and anti-dilution triggers by using convertibles as bridge, then raised proper Series D when market stabilized.

Lessons:

• Convertible notes/SAFEs valuable for bridge financing between equity rounds
• Can avoid down round and anti-dilution complications
• Must have strong existing investor support (often existing investors provide bridge)
• Risk: If Series D doesn't happen, convertible holders have uncertain exit

3.8 Action Items¶

1. Map Instrument Options to Your Situation: Create matrix with rows=funding instruments, columns=your stage/revenue/needs. Score each instrument 1-5 on suitability. This clarifies optimal instrument for current fundraising.

2. Model Conversion Scenarios for Convertible/SAFE: If considering convertible note or SAFE, build Excel model showing conversion outcomes at various Series A valuations ($10M, $20M, $30M pre-money). Calculate dilution in each scenario.

3. Calculate RBF Effective Cost: If monthly revenue>$50K, request RBF term sheets from GetVantage, Klub, and Recur Club. Model monthly payments at current revenue and 2x growth scenario. Calculate effective APR and compare to equity alternative.

4. Understand CCPS Documentation Requirements: Read sample CCPS term sheet and SHA from India-focused law firm. Understand liquidation preference, anti-dilution, conversion mechanics, and protective provisions. Flag any terms requiring clarification.

5. Prepare Venture Debt Application (if Series A+): If you've raised Series A+ and have 12+ month runway, approach InnoVen and Alteria for term sheets. Compare warrant coverage and interest rates. Model total cost vs equity alternative.

6. Audit Existing Convertibles on Cap Table: If you have outstanding convertible notes or SAFEs, model their conversion in next equity round. Verify caps, discounts, and accrued interest. Calculate total dilution from conversion.

7. Choose Instrument Before Starting Fundraise: Don't default to equity without considering alternatives. Make explicit decision: "We're raising $2M via [SAFE with $10M cap / CCPS Series A / RBF] because [specific rationale]."

8. Engage Lawyer Early for Instrument Selection: Before approaching investors, consult startup lawyer about instrument choice. Indian regulatory considerations may rule out certain options (e.g., SAFE with foreign investors).

9. Template Collection: Download standard templates for convertible note (SAFE template from YC, Indian convertible note template from lawyer). Review before negotiations so you understand baseline terms.

10. Prepare Alternative Scenarios: Build fundraising deck showing both equity round ($5M at $20M pre-money) and non-dilutive alternative ($2M RBF + $3M equity at $20M pre-money). Present both options to prospective investors and gauge reaction.

3.9 Key Takeaways¶

• Instrument selection should be deliberate strategic choice based on stage, revenue, and capital efficiency goals—defaulting to equity without considering convertibles or debt leaves money on table
• Convertible notes and SAFEs defer valuation but not dilution; founders trading 20-50% discount to Series A price for 3-6 month time savings must ensure that time is used productively to increase Series A valuation
• CCPS is Indian VC standard, providing investor protections (liquidation preference, anti-dilution) while complying with Companies Act Section 55; attempting alternatives requires strong rationale and investor buy-in
• Revenue-based financing and venture debt preserve equity but require revenue ($50K+ monthly for RBF, $500K+ ARR for venture debt) and create cash flow obligations that can strain business during down periods
• Post-money SAFE (Y Combinator 2018) eliminated valuation cap ambiguity, making SAFE conversion math clearer; however, limited Indian legal precedent makes convertible notes preferred for risk-averse investors

3.10 Red Flags to Watch¶

🔴 CRITICAL: Signing SAFE or convertible note without understanding conversion math - A $500K SAFE with $5M cap converting at $20M Series A gives investor 10% (not 2.5% based on $20M valuation). Model conversion scenarios before signing.

🔴 CRITICAL: Multiple convertibles with different caps creating complex waterfall - Three SAFEs at $6M, $8M, and $10M caps converting simultaneously into Series A creates three-tiered conversion pricing. Total dilution can exceed 25% unexpectedly.

🟡 Taking venture debt without 12+ month post-loan runway - If loan proceeds + existing cash only extends runway 8 months, mandatory repayment will exhaust cash before next milestone, forcing down round or bankruptcy.

🟡 Accepting participating preferred (double-dipping) liquidation preference - Participating preferred with 1x preference means investor gets investment back PLUS pro-rata share of remainder. This severely reduces founder proceeds in $30-80M exit range (Chapter 7: Term Sheet Analysis models exact impact).

🟡 RBF with revenue percentage >5% - Taking RBF at 6-8% of monthly revenue when provider offers 3-4% elsewhere means paying 2x cost for same capital. Shop multiple providers.

⚠️ Convertible note with <12 month maturity - Notes maturing in 6-9 months create forced conversion pressure before company ready for priced round, leading to unfavorable Series A terms or down round.

⚠️ CCPS without understanding anti-dilution provisions - Broad-based weighted average anti-dilution is standard and founder-acceptable; full ratchet anti-dilution is predatory and should be rejected (Chapter 11: Dark Patterns - Predatory Terms to Avoid models impact).

⚠️ Signing term sheet for instrument without consulting Indian lawyer - SAFE or US-style preferred stock may have enforceability issues in India. Verify instrument legal standing before proceeding.

3.11 When to Call a Lawyer¶

Situations REQUIRING lawyer:

• First institutional equity round (CCPS Series A/B) with SHA negotiation
• Convertible note with foreign investors requiring FEMA compliance
• Venture debt with complex covenants and warrant structure
• Multiple prior convertibles converting simultaneously (complex cap table math and documentation)

Situations where lawyer OPTIONAL but RECOMMENDED:

• SAFE from Indian angel investors (template-based, simpler)
• Standard convertible note from Y Combinator or other accelerator using their template
• RBF term sheet review (mostly commercial terms, less legal complexity)

Recommended Approach:

• Pre-Seed/Angel: Use standard SAFE/convertible templates with CA review for tax/compliance (₹25K-75K)
• Seed/Series A: Full legal engagement for SHA, CCPS structure, and compliance (₹3-10 lakh)
• Debt/RBF: Legal review of term sheet and covenants (₹50K-1.5 lakh)

Red Flag: Lawyer recommending expensive custom structure when standard instruments (CCPS, convertible note) would suffice. Push back on over-engineering.

3.12 Indian Context¶

Companies Act 2013 and CCPS Requirements¶

Section 55 of the Companies Act 2013 governs preference shares, requiring redemption within 20 years from issuance. CCPS structures avoid this by making conversion compulsory, not redemption.

Key Compliance:

• Issue price must be disclosed in term sheet (face value + premium)
• Special resolution required for preferential allotment under Section 62(1)©
• Form PAS-3 must be filed within 15 days of allotment
• Articles of Association must authorize preference share issuance and specify rights

Preferred Dividends: Section 55 allows cumulative or non-cumulative dividends. Most early-stage CCPS has 0.001-1% cumulative dividend (accruing to liquidation preference but rarely paid out unless exit or conversion).

RBI Convertible Note Treatment¶

RBI's Master Direction on Foreign Investment (January 2025 update) explicitly addresses convertible notes issued to non-residents:

• Minimum Investment: ₹25 lakh ($30,000) per foreign investor per investment
• Conversion Deadline: Within 5 years from issuance (strictly enforced)
• Pricing at Conversion: Must comply with FMV pricing guidelines (DCF, comps, or recent transaction)
• Interest: No restrictions; commercial negotiation
• Reporting: FC-GPR at issuance and at conversion

Key Risk: If company fails to raise priced round within 5 years, convertible note must convert to equity at fair market value OR be repaid. Most startups cannot repay, so forced conversion at potentially unfavorable valuation occurs.

Venture Debt and RBF Market Development¶

India's venture debt market reached ₹4,000 crore+ ($500M+) annual deployment by 2024, up from negligible levels in 2015. InnoVen Capital and Alteria Capital account for 60%+ of market. Average ticket size: ₹10-50 crore ($1.2M-$6M).

RBF market emerging slowly, with GetVantage (founded 2019) deploying ₹1,000+ crore across 150+ companies. Typical RBF ticket: ₹50 lakh to ₹10 crore ($60K-$1.2M). Monthly revenue share: 2-8% until 1.3-2.0x repayment.

Regulatory Status: Both venture debt and RBF treated as debt under Indian law, not subject to equity/FEMA regulations. This simplifies documentation but creates enforcement via debt recovery mechanisms rather than equity governance.

3.13 References¶

1. Feld, Brad, and Jason Mendelson, Venture Deals: Be Smarter Than Your Lawyer and Venture Capitalist, 4^th ed., Wiley, 2019.

2. Y Combinator, "SAFE (Simple Agreement for Future Equity) Templates," https://www.ycombinator.com/documents

3. Reserve Bank of India, "Master Direction on Foreign Investment in India," January 20, 2025, https://www.rbi.org.in/Scripts/BS_ViewMasDirections.aspx?id=11200

4. Ministry of Corporate Affairs, "The Companies Act, 2013 - Section 55 (Issue and Redemption of Preference Shares)," https://www.mca.gov.in/

5. Cooley GO, "Convertible Notes: The Complete Guide," https://www.cooleygo.com/convertible-notes-complete-guide/

6. Holloway, The Holloway Guide to Raising Venture Capital, https://www.holloway.com/g/venture-capital

7. InnoVen Capital, "Venture Debt in India: Market Overview," https://www.innovencapital.com/

8. GetVantage, "Revenue-Based Financing Explained," https://www.getvantage.in/

9. Inc42, "How Indian Startups Are Using Alternative Funding Instruments," https://inc42.com/resources/alternative-funding-indian-startups/

10. TaxGuru, "Convertible Notes in India: Raising Fund from Foreign Investors," https://taxguru.in/rbi/convertible-notes-india-raising-fund-foreign-investors.html

Navigation¶

Previous: Chapter 2: Valuation Fundamentals
Next: Chapter 4: Co-Founder Equity Splits and Vesting
Back to: Table of Contents

Related Chapters:

• Chapter 7: Term Sheet Analysis
• Chapter 16: Alternative Funding Strategies
• Chapter 22: Navigating the Indian Regulatory Framework

Disclaimer¶

This chapter provides educational information about startup funding and is not legal, financial, or investment advice. Every startup situation is unique. Consult qualified professionals (lawyers, accountants, financial advisors) before making any funding decisions.

Last Updated: November 2025