Convertible Note Agreement (Pakistan)

A Convertible Note Agreement in Pakistan governs the arrangement between the parties and the conditions on which it operates.

Convertible Notes in Pakistan are governed by multiple overlapping legal frameworks. The Companies Act 2017 (Act XIX of 2017) — the primary corporate statute administered by the Securities and Exchange Commission of Pakistan (SECP) — governs the issuance of debt securities and the conversion of debt into shares. Section 82 of the Companies Act 2017 empowers a company to issue debentures or other debt instruments, and the Convertible Note is structurally a debenture — a written acknowledgment of debt with provisions for conversion into shares. The issuance of debentures by a private company requires compliance with the Companies (General Provisions and Forms) Regulations 2018 and the company's Memorandum and Articles of Association (MOA/AOA), which must not prohibit the issuance of convertible instruments.

The Securities Act 2015 (Act XX of 2015) — administered by the SECP — governs the offering of securities to the public in Pakistan. For Convertible Notes issued by a private company to a small number of identified investors (not a public offering), the private placement provisions apply and the full public offering disclosure requirements do not apply. However, SECP's private placement regulations require that private placements of securities comply with the Companies (Private Placement of Securities) Regulations.

The Contract Act 1872 governs the contractual elements of the Convertible Note Agreement — the loan terms, repayment provisions, conversion mechanics, representations and warranties, and remedies for default. The Negotiable Instruments Act 1881 may also be relevant where the Convertible Note is structured as a negotiable instrument, though most Pakistani startup Convertible Notes are drafted as agreements rather than negotiable instruments.

Pakistan's startup ecosystem — centred in Karachi, Lahore, and Islamabad, with supporting institutions including the National Incubation Centre (NIC) network, the Pakistan Software Export Board (PSEB), and the Special Technology Zones Authority (STZA) — has increasingly adopted Convertible Note financing for seed-stage investments since 2018. Local angel investors, venture capital funds (such as Sarmayacar, i2i Ventures, Lakson Venture Capital, and Fatima Gobi Ventures), and international investors participate in Pakistani startup investment rounds using Convertible Notes as the primary instrument for seed and pre-seed stages, deferring equity valuation to the Series A round.

Foreign investment through Convertible Notes in Pakistani companies requires compliance with the Foreign Exchange Regulations Act 1947 (FERA) and the State Bank of Pakistan (SBP) Foreign Investment Policy. Foreign investors must remit investment funds through normal banking channels and receive SECP approval for the equity conversion when triggered. The SBP's regulations on foreign equity participation and repatriation of profits/returns apply to the converted equity after the Convertible Note matures into shares.

A Convertible Note Agreement in Pakistan is required when a startup or early-stage company needs to raise capital quickly from investors without the delay and cost of a full equity valuation negotiation, and both parties prefer to defer equity pricing to a later, larger funding round.

A Convertible Note Agreement is needed when a Pakistani startup at the pre-seed or seed stage — a technology company, fintech, health-tech, edtech, or e-commerce startup — requires bridge financing of PKR 5 million to PKR 50 million from angel investors, friends-and-family investors, or early-stage venture capital funds to fund product development, team building, and initial market validation, before the company is ready for a formal Series A equity round with full due diligence and valuation.

A Convertible Note Agreement is required when a company needs bridge financing to carry it through to its next equity round — for example, where the Series A is expected in six to twelve months but the company needs capital immediately to continue operations. The Convertible Note bridges the gap without diluting founders at an artificially low valuation during the interim period.

A Convertible Note Agreement is needed when an existing investor in a Pakistani company wants to make a follow-on investment before a new equity round is priced, investing additional capital that will convert into shares in the next round on the same terms as new investors (or at a discount to reward the early risk).

A Convertible Note Agreement is required when a Pakistani company is raising capital from multiple angel investors at different times over a period of several months — the Convertible Note allows each investor to invest on the same instrument structure without requiring a separate share subscription agreement and share allotment for each investor at each point in time.

A Convertible Note Agreement is needed when a foreign investor wishes to invest in a Pakistani startup but the SECP foreign investment approval process for direct equity investment would take longer than the startup's funding timeline allows — the Convertible Note can be structured as a debt instrument initially, with conversion to equity occurring after necessary regulatory approvals are obtained.

A thorough Convertible Note Agreement in Pakistan under the Companies Act 2017, Contract Act 1872, and Securities Act 2015 must contain the following essential elements to be valid, enforceable, and compliant with SECP regulations.

Party Identification: Full legal name and address of the issuing company (registered with SECP, including company registration number and NTN from FBR), the names and designations of the authorised signatories (directors authorised by a board resolution), and the full legal name, address, CNIC number (for individual investors) or registration details (for institutional investors) of the investor(s). Where the investor is a foreign entity, their country of incorporation and foreign registration details must be stated for SBP and SECP compliance.

Principal Amount and Drawdown: The principal amount of the loan in Pakistani Rupees (or, for foreign investors, the equivalent in the investor's currency with the exchange mechanism specified), the date of drawdown, and — if the note allows multiple drawdowns — the schedule and conditions for each tranche.

Interest Rate: The annual interest rate on the principal — typically 8% to 15% per annum for Pakistani startup Convertible Notes. The interest may accrue and convert into equity alongside the principal (most common in startup Convertible Notes) or may be payable periodically in cash. Where the interest rate is above the State Bank of Pakistan's (SBP) published maximum lending rate, SECP and SBP may scrutinise the instrument as a usurious loan under the Usurious Loans Act 1918.

Maturity Date: The date on which the Convertible Note matures — typically 12 to 24 months from issuance. At maturity, if no qualifying equity financing event has occurred, the note either: (a) converts automatically into equity at a pre-agreed fallback conversion price; or (b) becomes repayable in cash with accrued interest; or (c) is extended by mutual agreement. The maturity provision must be clearly stated to avoid disputes.

Conversion Triggers (Qualifying Financing Event): A clear definition of the events that trigger automatic conversion of the Note into equity — typically a new equity financing round in which the company raises a minimum specified amount (the 'Qualifying Financing Amount') from new investors. The Qualifying Financing Amount for Pakistani startups is typically set at PKR 50 million to PKR 200 million, or the equivalent in USD.

Conversion Discount and Valuation Cap: The conversion discount — typically 15% to 25% — that the Convertible Note investor receives on the share price at the Qualifying Financing Event, as compensation for investing earlier and at higher risk. The valuation cap — the maximum pre-money valuation of the company at which the Convertible Note converts, regardless of the actual valuation at the Qualifying Financing Event — is the other key investor protection. These two provisions, together, determine the effective equity price for the Convertible Note investor.

SECP Compliance — Share Issuance: Upon conversion, the company must comply with the Companies Act 2017 — a board resolution authorising the share allotment, filing of Form 3 with SECP (return of allotment) within 30 days of allotment, and updating the company's share register. For companies with foreign investors, SECP's foreign equity regulations and SBP's foreign exchange regulations for equity investments apply.

Representations and Warranties: Standard representations by the company — that it is duly incorporated under the Companies Act 2017, that the note issuance is authorised by the board, that there are no undisclosed liabilities, that the company owns its intellectual property, and that no legal proceedings are pending that could materially affect the business.

Default and Acceleration: Events of default — failure to repay at maturity, insolvency, material breach of representations — entitling the investor to accelerate and demand immediate repayment of the principal and accrued interest.

Forms-legal.com provides this Convertible Note Agreement (Pakistan) template as a starting framework for seed-stage startup financing. The template reflects requirements under the Companies Act 2017, the Contract Act 1872, the Securities Act 2015, and the Foreign Exchange Regulations Act 1947. Pakistani startups and investors should engage a corporate lawyer or an advocate at a provincial Bar Council with SECP and startup finance experience to review and customise the note for each specific investment round.

Under the State Bank of Pakistan (SBP) Act 1956, the SBP regulates banking. The Securities and Exchange Commission of Pakistan (SECP) regulates capital markets under the Securities Act 2015. Section 4 of the Negotiable Instruments Act 1881 governs promissory notes. The Federal Board of Revenue (FBR) administers tax obligations under the Income Tax Ordinance 2001. The Sales Tax Act 1990 governs indirect taxation.