Under FEMA, only certain instruments count as foreign equity investment – and the line matters enormously. Get it right and you are under the FDI regime: no repayment obligation, no maturity, reported once on FC-GPR. Get it wrong – an optionally convertible note, an assured-return clause – and the instrument is debt, dragged into the ECB framework with its own rules. This guide covers every qualifying instrument, the Rule 21 pricing guidelines, and the structures investors actually use in Indian startups and subsidiaries.
The qualifying instruments
| Instrument | Key FEMA conditions | Typical use |
|---|---|---|
| Equity shares | Fully paid on allotment; partly-paid permitted with 25% upfront and balance within 12 months | Subsidiary capitalisation, founder rounds |
| CCPS (compulsorily convertible preference shares) | Must be fully and mandatorily convertible; conversion price or formula fixed upfront; conversion cannot be below fair value at issue | The venture-capital standard in India |
| CCDs (compulsorily convertible debentures) | Same conversion discipline; interest until conversion is possible but scrutinised | Bridge structures, structured rounds |
| Share warrants | 25% upfront, balance within 18 months; price/formula fixed upfront | Strategic top-up rights |
| Convertible notes | Only for DPIIT-recognised startups (approval-route sectors need clearance); minimum ₹25 lakh per investor per tranche; convert or repay within 10 years; Form CN within 30 days | Early-stage angel rounds – see the NRI investment guide for the non-repat variant |
Pricing guidelines – Rule 21 in practice
| Transaction | Pricing rule |
|---|---|
| Issue of shares to a non-resident (unlisted company) | Price not less than fair value per an internationally accepted pricing methodology on arm’s-length basis – certified by a practising CA, SEBI-registered merchant banker, or practising cost accountant |
| Issue by a listed company | SEBI preferential-issue pricing formula |
| Transfer resident → non-resident | Price not less than the fair-value floor (NR cannot buy cheap) |
| Transfer non-resident → resident | Price not more than fair value (NR cannot be given an assured premium exit) – reported on FC-TRS |
| Share swap | Valuation by a SEBI-registered merchant banker (or overseas investment banker) |
| Rights issue to existing NR holders | Price offered to residents; but renounced/unsubscribed portions taken by NRs need fresh fair-value pricing (2025 clarification) |
| Non-repatriation basis (NRI/OCI Schedule IV) | No pricing guidelines apply – deemed domestic |
Deferred consideration and escrow
In resident↔non-resident share transfers, up to 25% of consideration may be deferred for up to 18 months, or parked in escrow for 18 months, or covered by a seller indemnity (same limits). Each tranche that moves is reported. Since January 2025, foreign-owned Indian companies (FOCCs) can use the same deferred/escrow mechanics in downstream acquisitions – a significant structuring unlock for M&A.
Choosing the instrument – a practical matrix
| Situation | Sensible instrument | Why |
|---|---|---|
| Parent capitalising its wholly-owned subsidiary | Equity shares | Simple, permanent, no conversion mechanics to manage |
| VC investing in a startup priced round | CCPS | Liquidation preference + anti-dilution within FEMA limits |
| Angel/NRI cheque before a priced round | Convertible note (if DPIIT-recognised) or CCD | Defers valuation; CN needs no valuation certificate at issue |
| Founder wants foreign capital without cap-table change now | Share warrants | 25% now, price locked, balance in 18 months |
| Parent wants repayable support | Not an FDI instrument – use an ECB | Debt belongs in the debt framework, now much friendlier post-Feb 2026 |
Structuring a round or a capitalisation?
We draft the instrument terms, run the valuation, and file FC-GPR/CN on time – one desk for the legal-tax-FEMA triangle.
Talk to My Cloud AccountantFrequently asked questions
Can a foreign investor get an assured return on equity in India?
No. FEMA bars assured-exit pricing for non-residents – the exit must happen at (or below, for NR sellers) fair value at the time of exit. Structures promising fixed returns on equity instruments risk recharacterisation as debt and FEMA penalties.
Who can issue the FDI valuation certificate?
A practising Chartered Accountant, a SEBI-registered merchant banker, or a practising cost accountant – using an internationally accepted methodology. Swaps need a merchant banker specifically.
What is the minimum investment in a convertible note?
₹25 lakh per investor in a single tranche, and only DPIIT-recognised startups can issue CNs. The note must convert or be repaid within 10 years. Reporting is via Form CN on FIRMS within 30 days.
Is interest on CCDs allowed?
Yes, CCDs can carry a coupon until conversion, but aggressive coupons attract scrutiny – the instrument must remain equity-like in substance. The coupon is also subject to withholding tax as interest.
Based on the FEM (NDI) Rules 2019 (Rules 2, 9 and 21) as amended, and the RBI Master Direction on Foreign Investment (updated January 2025). Last reviewed: July 2026.