State Bank of Pakistan has proposed a new type of loan for supporting startups to meet the specific needs in raising capital for setting up business and operations on a sustainable basis.
A startup company may raise funds from abroad in the form of convertible debt, i.e., the lender shall have the option to convert the loan into the equity of the borrowing company.
These are the terms and conditions:
- The borrowing company is 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 has annual revenue below Rs. 2 billion since its incorporation.
- The borrowing company has equity (including retained earnings) below Rs. 300 million as per the latest audited financials.
- The requirement of long-term credit rating shall not be applicable.
- In addition to the eligible lenders, funds can be raised from all those investors eligible for the issuance of shares.
- The maturity of such loans shall range from one (1) year to five (5) years. The loans may be rolled-over subject to the condition that its total tenor will not exceed five years, in any case.
- For the maturity period ranging from 1 to 3 years, borrowing cost ceiling excluding benchmark rate set at 250bps. For the maturity period ranging 3 to 5 years, borrowing cost ceiling excluding benchmark rate set at 350bps. The borrowing cost ceiling includes spread over relevant benchmark rate, loan-related insurance premium, and other loan-related fees payable in foreign currency, except the commitment fee, cost and expenses, and fees payable in local currency.
- The funds borrowed under this category can be credited in a foreign currency account opened and maintained in terms of para 9, Chapter 6 of the Foreign Exchange Manual.
- 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 into equity of the borrowing company on or before the maturity of the loan. The borrowing company may issue shares in favor of the lender, per para 6 and 7 of Chapter 20 of the Foreign Exchange Manual. However, the shares cannot be issued below the latest break-up value as determined by the external auditors included in category A of the State Bank’s approved list of Auditors.
- The rupee liability of the loan (including accrued profit/mark-up) shall be determined by converting the FCY loan amount, outstanding as per last month-end or quarter-end (in the case where the last month-end figures are not available) financial statement, into PKR by using the prevalent mark-to-market exchange rate (mid-rate) announced by the State Bank of Pakistan.
- The facility of forward cover shall not be available.
Issues and Challenges of Startup Companies:
SBP proposed a new type of loan and the revision of foreign exchange rules after discussing with the representatives of Startups and Venture Capital (VC), which have highlighted that current foreign exchange regulations governing borrowing from abroad, do not meet the requirements of Fintech and Startup companies.
As per these stakeholders, foreign investors, at times, intend to invest in their companies in the form of convertible debt (i.e., loan convertible into equity) instead of directly investing as equity, according to the working paper released by SBP on this issue.
It has been observed that foreign investors, including Venture Capital/Private Equity funds and angel investors, usually take an interest to invest in startups. However, keeping in view the financial risks associated with startup companies, at times they prefer to provide funds initially as loans and subsequently decide about participation in the equity of the company.
Startup firms also face funding issues due to the unavailability of collateral/ security, which is a prerequisite by most lenders. However, VC firms and angel investors then try to cover the risk through alternate means. Thus, sometimes foreign investors charge a premium for taking such risk in the form of a high return on loan amount or discount at the time of issuance of shares.