KARACHI: The State Bank of Pakistan (SBP) on Wednesday removed a major hurdle that has been hampering growth of the startup companies by allowing them to avail foreign loans as convertible debt.

The central bank said that in order to facilitate the startup companies in raising financing from abroad, it has allowed them to avail loans as “convertible debt”.

In order to borrow from foreign investors, once again, the law as it stands currently bans individuals from such borrowing, and only allows Pakistani companies to do so under very limited circumstances. It restricts the whole purpose of raising convertible debt for a startup, since the point is to get money fast from existing investors.

There has been demand from the startup companies to allow foreign loans that may be converted into equity.

Changes have been introduced in the Foreign Exchange Manual

In case of successful startups, they raise an initial round of funding and start selling their products or service to their targeted customers. However, in case of higher growth they require more funding, the startup companies want to get loans from abroad but the State Bank regulations were hurdle in this way.

“Convertible debt is a type of financing with the option that it may be converted into equity shares of the borrowing company, subject to certain terms and conditions,” said the SBP.

Before the latest instructions, entities were allowed to raise foreign currency loans from abroad within the parameters defined in the Foreign Exchange Manual (FEM), but there was no specific category that provided the option of convertibility of loan in to equity of the borrowing company.

Startup firms face funding issues due to unavailability of collateral or security. Foreign investors including equity funds and angel investors show interest in startups but they try to cover the risk through alternative means like high return on loan.

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.

“It is expected that this initiative will help in attracting more foreign investment as it will provide another option to the international investors to invest in startup companies operating in Pakistan,” said the SBP.

The foreign investors, who are hesitant to participate in the equity of startup company at initial stage, may provide financing under this category and decide about participation in equity at some later stage.

In order to implement these changes, relevant provisions of Chapter 19 of FEM have been updated, said the SBP.

Earlier, in February this year a working paper “Raising of convertible debt from abroad by startup companies” issued by the State Bank said a new type of loan scheme to meet the specific needs of startup companies is being designed.

According to the working paper, startups and venture capital firms maintain that foreign investors intend to invest in their companies in the form of convertible debt (ie loan convertible into equity) instead of directly investing as equity while the current foreign exchange regulations remain unable to provide this facility.

Published in Dawn, May 27th, 2021