When startups in India look to scale, they often tap into foreign capital — whether through direct investment, overseas expansion, or international borrowing. But when money crosses borders, it comes under the scope of India’s foreign exchange laws.
The Foreign Exchange Management Act (FEMA) is what governs all such transactions — receipts, payments, and cross-border movement of capital. And over the years, FEMA has added specific carve-outs for startups to make it easier for them to raise and use foreign funds without getting tangled in red tape.
This blog — Part 7 of the M2K Startup Series — explains the major exchange control provisions that apply to startups. We’ll look at the general rules for FDI, startup-specific relaxations, rules around outbound investments, borrowing from abroad (ECB), opening foreign accounts, and the consequences of non-compliance.
Foreign Direct Investment (FDI) in General
FDI is when a person resident outside India (PROI) invests in a company in India. For unlisted companies — like most startups — any equity investment counts as FDI. For listed companies, the rule applies only if the PROI holds 10% or more of post-issue paid-up equity.
There are rules and limits that govern these investments:
• Sectors may be under automatic or government approval routes.
• Sectoral caps apply to how much foreign investment is allowed.
• Pricing must follow fair valuation norms.
• Once the funds are received, equity instruments must be issued within 60 days. If not, the money must be refunded within 15 days after that period.
Startups can also issue ESOPs or sweat equity shares to foreign employees or directors (if they qualify as PROI).
If a PROI sells or gifts their shares to a resident Indian, the transfer must follow pricing guidelines. All these activities must be reported:
• Form FC-GPR: For new equity issued to PROI
• Form FC-TRS: For transfer of shares between resident and non-resident
• Form FLA: Annual foreign liabilities and assets report
The resident (Indian company) is responsible for filing all these.
FDI – Additional Route for Startups
Startups have an added route for raising funds from foreign investors: Convertible Notes.
This is a hybrid instrument — it starts as debt, but can later turn into equity if certain events occur. It gives investors a way to come in early without committing to valuation right away.
Here’s what the rules say:
• Convertible Notes can be issued to PROIs for ₹25 lakh or more in one tranche.
• The note must be converted into equity or repaid within five years.
• The issue must comply with automatic route conditions if the startup’s sector doesn’t require government approval.
Startups issuing convertible notes must:
• File Form CN within 30 days of issue
• Also file Form CN within 30 days for any transfer of convertible notes between resident and PROI
When the notes convert to equity, all the usual FDI rules — sectoral caps, pricing, entry route, etc. — still apply.
FDI – Additional Route for Startups (FVCI)
Foreign Venture Capital Investors (FVCIs) offer another way for startups to raise money.
An FVCI is an entity:
• Incorporated outside India
• Registered with SEBI
For startups, FVCIs get a special benefit — they can invest in any sector, through:
• Equity shares
• Equity-linked instruments
• Debt instruments
If the FVCI is investing in equity, regular rules like pricing guidelines and sectoral caps still apply.
Usually, FVCIs can only invest in certain specified sectors such as:
• Biotech
• IT hardware/software
• Nanotech
• Pharma R&D
• Seed R&D
• Dairy, poultry, biofuels
• Hotels with large convention centres
• Infrastructure
But startups are an exception — they can receive FVCI investment regardless of their sector.
Overseas Direct Investment (ODI)
Startups in India may also want to invest outside India, especially if setting up a global presence.
ODI rules apply when an Indian company puts money into an overseas joint venture (JV) or wholly owned subsidiary (WOS).
Here’s what’s allowed:
• Investment can be up to 400% of the company’s net worth, subject to a cap of USD 1 billion per financial year.
• Corporate guarantees given to the foreign entity count toward this limit.
• Any loan to the JV/WOS must be backed by equity — if not, it goes under approval route.
• Share certificates must be received within 6 months of remittance or capitalization.
If money is due back from the foreign entity (e.g. from exports), it must be repatriated within 60 days of becoming due. Startups can also capitalize these receivables, but doing so after the time limit requires RBI approval.
If there’s a share swap, valuation must be done by:
• A SEBI-registered Category I Merchant Banker (India), or
• A registered investment/merchant banker in the host country
Startups also have to:
• Report ODI using Form ODI Part I and III at the time of investment and disinvestment
• File Form FLA annually (by July 15)
• File Form APR (Annual Performance Report) by December 31
• Inform AD Banker of changes in Indian party or step-down subsidiaries
These ODI rules apply equally to startups.
External Commercial Borrowings (ECB)
In General ECBs are loans taken by Indian companies from lenders outside India.
Here’s a breakdown of general ECB rules:
• Any entity eligible to receive FDI can raise ECB
• Lenders must be from FATF/IOSCO compliant countries
• Minimum average maturity (MAMP) is 3 years — or longer, depending on purpose
• All-in-cost ceiling is benchmark rate plus 450 bps
(includes interest, fees, charges, excluding commitment fees and withholding tax)
Startups must:
• Get a Loan Registration Number (LRN) by submitting Form ECB to their AD Bank
• Report all ECB transactions monthly via Form ECB-2 return
There’s also a negative list — ECB money can’t be used for things like real estate, capital market investment, etc.
ECB – Relaxation for Startups
Startups get a relaxation in ECB rules.
Here’s what changes for them:
• AD Category-I banks can approve ECBs to startups under the automatic route
• Minimum average maturity is reduced to 3 years (compared to 5 or 10 years for others)
• The ECB amount is capped at USD 3 million per financial year
• Money can be used for any business expenditure, unlike general ECB end-use restrictions
• ECB can be in the form of loans, non-convertible, optionally convertible, or partially convertible preference shares
• Conversion to equity is freely permitted, subject to regular FDI rules
• Cost of borrowing can be mutually decided between startup and lender
This makes ECB a flexible option for startups who want debt without giving up equity right away.
Deposits and Accounts
Startups involved in exports — or who have overseas subsidiaries — can open and operate foreign currency accounts.
Two types of accounts are allowed:
- EEFC Account (Exchange Earner’s Foreign Currency) – with AD Banker in India
• Startups can credit this account with foreign currency received from exports or overseas sales.
• This includes income from their overseas subsidiaries. - Foreign Currency Account Outside India
• A startup with an overseas subsidiary can open a foreign bank account abroad
• Export proceeds or sales revenue from that entity can be credited into that account
• But the foreign currency must be repatriated back to India within the deadline specified under FEMA
This flexibility helps startups manage global operations, while still staying compliant with Indian forex laws.
Typical contraventions by Indian entities/startups
FEMA compliance is strict. Common mistakes by startups include:
Under FDI:
• Not issuing shares/refunds in time
• Missing deadlines for filing FCTRS, FCGPR, or FLA
• Issuing non-permissible instruments
• Using unapproved funding methods
Under ODI:
• Delay or failure to file APR
• Delay in obtaining share certificates
Under ECB:
• Failing to get Loan Registration Number (LRN)
• Not filing ECB-2 monthly returns
• Using borrowed money for prohibited activities
Each of these can result in penalties.
Penal Provisions
FEMA violations are taken seriously. Penalties depend on whether the violation is quantifiable or not:
• Up to ₹2 lakhs for non-quantifiable breaches
• Up to 3x the amount involved for quantifiable violations
• ₹500 per day for continuing contraventions beyond the first day
In some cases, the currency or property involved can be confiscated by the government. The authority can also direct foreign assets to be brought back to India.
Final thoughts
Exchange control isn’t just a backend compliance function. For startups, it directly affects how much capital you can raise, how fast you can scale internationally, and how confidently you can grow without regulatory risk.
Whether you’re bringing money in (FDI, FVCI, convertible notes, ECB) or sending money out (ODI, overseas expansion), the key is timely compliance and correct reporting.
Startups now have multiple paths to work with foreign capital — but with that freedom comes responsibility. A small slip in reporting or delay in filings can result in penalties that wipe out the advantage.
So get familiar with the FEMA framework, file every form on time, and always loop in your advisors before you act.
