Venture Debt Secured NCD (2026): The Section 42 Penalty That Can Cost ₹2 Crore and the 15-Day PAS-3 Filing Founders Miss

A Bengaluru SaaS founder closed a ₹18 crore venture debt round last year, drew the money into the company’s current account the same week, and started paying salaries out of it. Six weeks later, during a Series B data-room review, the incoming lead’s counsel asked one question: “Where is your PAS-3 for the debenture allotment?” There was none. The company had raised money through a venture debt secured NCD, used it before filing the return of allotment, and tripped Section 42 of the Companies Act, 2013, the private placement provision that carries a penalty running up to ₹2 crore. The round did not collapse, but the clean-up cost the founder six weeks and a governance flag the investor never forgot.

Venture debt is now standard in the Indian startup stack, sitting alongside equity from seed to Series C. Almost every rupee of it comes in through secured non-convertible debentures issued on private placement. The term sheet is the easy part. The compliance around it (the debenture trustee, the charge, the debenture redemption reserve, the PAS-3 clock) is where founders and their finance teams quietly slip.

The problem: founders treat a venture debt secured NCD like a loan

A bank term loan needs a sanction letter, a board resolution and a charge filing. Founders assume venture debt is the same paperwork with a fund’s name on it. It is not. A secured NCD is a security, and issuing a security to selected investors is a private placement governed by Section 42, Section 71 and Rule 18 of the Companies (Share Capital and Debentures) Rules, 2014. Miss the sequence and three separate things break: the Section 42 penalty attaches, the charge can be held void, and in the worst case the money is re-characterised as a deposit.

The re-characterisation risk is the one nobody sees coming. Under the Companies (Acceptance of Deposits) Rules, 2014, a private company cannot issue an unsecured non-convertible debenture unless it is listed. Do so and the amount is treated as a deposit under Section 73, which private companies are largely barred from accepting. That is why venture debt is almost always structured as a secured NCD with a real charge behind it. If the security paperwork is thin or late, the “secured” label weakens, and the deposit question opens up.

The numbers are not small. In a typical growth-stage round the money involved runs into crores, and Section 42(10) sets the penalty at the amount raised or ₹2 crore, whichever is lower, on the company and on each promoter and director, with a separate obligation to refund every rupee with interest within 30 days. A procedural slip on a ₹15 crore draw is not a ₹10,000 late fee. It is a board-level exposure.

The venture debt secured NCD compliance clock

The sequence below is what a clean secured NCD issue looks like from board approval to charge filing. Every step has a form and a deadline, and the order matters. You cannot, for example, dispatch the PAS-4 offer letter before the MGT-14 is filed.

• 1Day 0: Board meetingBoard approves the NCD issue and terms, the draft PAS-4 offer-cum-application letter, the debenture trustee, the debenture trust deed and a separate bank account for subscription money.
• 2Within 30 days of the board resolution: MGT-14File the board resolution for the debenture issue with the Registrar under Section 179(3).
• 3Before the offer letter: debenture trusteeAppoint the debenture trustee before the letter of offer goes out for a secured NCD, and take their written consent.
• 4Offer stage: PAS-4 and PAS-5Dispatch the PAS-4 offer letter only to identified persons (a cap of 200 in a financial year, per kind of security), keep the PAS-5 record, and collect subscription money only through banking channels into the separate account, never cash.
• 5Within 60 days of subscription money: allotmentAllot the debentures by a board resolution, create the charge and authorise the debenture certificates.
• 6Within 15 days of allotment: PAS-3File the return of allotment. The money cannot be used until PAS-3 is filed.
• 7Within 60 days of allotment: debenture trust deedExecute the debenture trust deed (Form SH-12) with the trustee.
• 8Within 30 days of charge creation: CHG-9Register the charge in favour of the debenture trustee. An unregistered charge is void against the liquidator and other creditors.

What actually changed, and what founders keep getting wrong

Two settings inside this framework have moved in the company’s favour, and both are widely misunderstood.

First, the debenture redemption reserve. The DRR is a slice of distributable profit that is locked away for repaying debenture holders. For unlisted companies, it now stands at 10% of the value of the outstanding debentures, cut down from the older 25% figure. It is carved out of profits available for dividend, so a loss-making company is not required to create it. It applies to non-convertible debentures, not to compulsorily convertible debentures; for a partly convertible instrument, only the non-convertible portion attracts DRR. Non-banking financial companies registered with the RBI and housing finance companies registered with the National Housing Bank are exempt for privately placed debentures.

Second, the debenture redemption investment, which founders routinely confuse with the DRR. This is a cash requirement, not an accounting one. For a secured NCD, on or before 30 April each year the company must invest or deposit a sum of at least 15% of the debentures maturing during the year ending on 31 March of the next year, in specified instruments such as scheduled-bank deposits or unencumbered Central or State Government securities. That money is ring-fenced for redemption and cannot be used for anything else. A startup that raised a three-year NCD and forgot the 30 April deposit has a live default sitting on its books, regardless of how healthy the cash position looks.

The mistake that recurs across data rooms is simpler than any of this: using the money before PAS-3 is filed. The subscription amount must sit in the separate bank account until the return of allotment is on record. Sweep it into operations on day one and the private placement is defective from the start.

Penalty exposure at a glance

Different slips carry very different price tags. The exposure is not a single fine. It is the way the defaults stack on top of each other when a venture debt round is run informally.

What you must do now: the founder checklist

Run the issue as a governed private placement from the board meeting onward. The steps below are the ones that keep a venture debt secured NCD clean and diligence-ready.

1. Convene the board meeting first. Approve the NCD terms, the draft PAS-4, the trustee, the trust deed and the separate bank account in one sitting. Nothing goes to the investor before this.
2. File MGT-14 within 30 days. The Section 179(3) board resolution to issue debentures has to reach the Registrar inside the window, or Section 117 penalties start.
3. Appoint the debenture trustee before the offer letter. For a secured NCD this is not optional, and their consent must be on record before PAS-4 is dispatched.
4. Open and use a separate bank account. Subscription money comes in only through banking channels, only from the identified persons, and stays there untouched.
5. Respect the 200-person cap. Count offers across the financial year for that kind of security. Cross 200 and the issue is deemed a public offer, which a private company cannot make.
6. Allot within 60 days and file PAS-3 within 15 days of allotment. Do not draw the funds into operations until the return of allotment is filed.
7. Register the charge with CHG-9 within 30 days. Late registration needs a separate application, and an unregistered charge protects nobody in an insolvency.
8. Execute the debenture trust deed within 60 days of allotment and update the register of debenture holders.
9. Diarise the DRR and the 30 April 15% deposit. Put both into the compliance calendar the day the NCD is allotted, not the year it matures.
10. If a foreign fund is subscribing, layer the FEMA reporting on top. A non-resident subscription brings its own filing track, separate from the Companies Act steps.

The deeper implication

According to CS Sapna Malpani, a Practising Company Secretary in Bengaluru, the venture debt structure is where a young company’s governance is tested for the first time under real money pressure. “Equity rounds are heavily lawyered, so founders assume the debt round is lighter. It is the opposite. A secured NCD touches Section 42, Section 71, the charge provisions and the deposit rules all at once, and the defaults are cumulative. When a Series B investor’s counsel opens the data room, the debenture file is the first place a weak compliance function shows,” she notes.

The forward view is straightforward. As venture debt volumes keep rising and more rounds involve overseas AIFs and offshore lenders, the debenture file will carry both Companies Act and FEMA weight, and diligence teams will treat a missing PAS-3 or an unregistered charge as a proxy for how the whole company is run. The founders who set up the calendar at allotment, rather than reconstructing it during diligence, are the ones who keep their next round on schedule.

How a secured NCD compares to the instruments founders confuse it with

Three instruments get mixed up in fundraising conversations, and each carries a different compliance load.

A secured NCD is pure debt: fixed interest, a redemption date within ten years, a charge on assets, a debenture trustee and DRR. A compulsorily convertible debenture starts as debt but must convert to equity, so it does not attract DRR and, when subscribed by a foreign investor, is treated as an equity-like instrument under FEMA. A plain equity private placement under Section 62(1)(c) uses the same Section 42 machinery (PAS-4, the 200-person cap, PAS-3) but has no trustee, no charge and no redemption reserve. The common thread is Section 42; the divergence is everything that hangs off the “secured” and “non-convertible” labels. Choosing the wrong instrument on the term sheet quietly commits the company to the wrong compliance track.

Sources and references

1. Companies Act, 2013, Section 42 (private placement) and Section 71 (debentures), India Code: indiacode.nic.in
2. Section 71, Debentures, Companies Act Integrated Ready Reckoner: ca2013.com/debentures
3. Companies (Share Capital and Debentures) Rules, 2014, Rule 18, MCA: mca.gov.in
4. Issue of Secured, Non-Convertible Debentures by a Private Company, TaxGuru: taxguru.in
5. Venture Debt Funding by way of Issue of Debentures by a Private Company, TaxGuru: taxguru.in
6. Listed NCDs by Private Companies in India: Legal Guide, King Stubb & Kasiva: ksandk.com