Pakistan’s central bank is considering relaxing rules for start-up companies to raise foreign financing, as it may allow the firms to raise “convertible debt” from abroad, according to a working paper.

It elaborated that the start-ups may be allowed to raise debt, which may be converted into equity later on.

A new type of loan may be introduced to meet the specific needs of start-up companies keeping in view the issues they are facing in raising capital, in the form of convertible debt, from abroad under current regulations.

A company may raise funds from abroad in the form of convertible debt ie the lender shall have the option to convert the loan into equity of the borrowing company, subject to following terms and conditions; the borrowing company should be incorporated as a private limited/public unlisted company under the Companies Act, 2017 (erstwhile Companies Ordinance 1984) for not more than seven years, provided that such entity is not formed by splitting up, or reconstruction of a business already in existence.

The borrowing company should have annual revenue below Rs2 billion since its incorporation. It should have equity (including retained earnings) below Rs300 million as per latest audited financials.

The maturity of such loans shall range from one year to five years. “The loans may be rolled-over subject to the condition that its total tenor will not exceed five years, in any case,” it said.

The principal can be repaid in bullet payment on maturity and no prepayments would be allowed.

The outstanding loan amount, including accrued profit/mark-up, can be converted in to equity of the borrowing company on or before the maturity of the loan.

The borrowing company may issue shares in favour of lender. “However, the shares cannot be issued below the latest break-up value as determined by the external auditors included in the category A of the State Bank’s approved list of Auditors,” it said.

During discussions over the last one year the representatives of start-ups and venture capital (VC) firms have highlighted that current foreign exchange regulations governing borrowing from abroad, do not meet the requirements of fintech and start-up companies.

“As per these stakeholders, foreign investors, at times, intend to invest in their companies in the form of convertible debt (ie loan convertible in to equity) instead of directly investing as equity,” the State Bank of Pakistan said in the notification.

Currently, only project loans can be converted into equity either after completion of the project or after three years, whichever is later, only after obtaining prior approval of Exchange Policy Department, it said.

It has been observed that foreign investors including venture capital/private equity funds and angel investors usually take interest to invest in start-ups; however, keeping in view the financial risks associated with start-up companies, at times they prefer to provide funds initially as loan and subsequently decide about participation in the equity of the company, it said.

Published in The Express Tribune, February 10th, 2021.

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