Gary Vaynerchuck, a famous American Entrepreneur, best known for his work in digital marketing and social media, made a very remarkable statement in one of his lectures, ‘I look at only two things when angel investing. Are you solving an important problem? Do you care about the end users?’
Alternative Investment Funds (AIF) are primarily the funds that are established with a defined purpose, considering the interests of the investees and the investors. Generally, growing investees and startup companies seek help from the AIFs when all other means of pitching in investment becomes a herculean task for them. AIFs, unlike the traditional modes of investment such as stocks, bonds, cash, and property are privately pooled investment vehicles that derive funds and raise capital primarily from the High Net worth Investors with a view to investing in accordance with a defined investment policy for the benefit of the investors. An investee Company may be a Special purpose vehicle, Limited Liability Partnership, a body corporate, Real Estate Investment Trusts, and Infrastructure Investment Trusts.
These AIFs can be registered as a Company, a Trust, a Limited Liability Partnership and a Body Corporate in India, and are governed by the SEBI (Alternative Investment Fund), Regulations, 2012. According to a report by SEBI, 100 new AIFs came into existence in the financial year 2018-19 adding up to a total of 462, whereby investments in AIFs increased by 30 percent to Rs.1.8 lakh crore. Thus, considering the indispensable role AIFs play by parking the investor’s resources in alternate funds, it becomes imperative to understand the conditions that govern the AIFs.
This write up attempts to furnish a broad picture of AIF Regulation in India, throws light on various types of Alternative Investment Funds, respective contributions and corpus for each fund, sponsor’s contribution, and lock in, conditions for regulated funds, and the tenure of the schemes, etc.
Alternative Investment Funds provide an alternative to other forms of investment. Investors while investing in alternative investment funds are subject to high risk due to uncertain business models of the corporations. However, considering the high returns evolving out of such risky ventures, the investors prefer to invest in alternative sources for diversification of their portfolio. Multiple small investments in numerous start-up companies or other companies give an alternative to the investors.
1. Family Trusts
2. ESOP Trusts
3. Employee Welfare trusts or gratuity Trusts
4. Holding Companies as defined under Section 2(46) of the Indian Companies Act, 2013
5. Any securitization trusts, regulated under a specific regulation
6. Funds regulated and managed by Securitization Company or Reconstruction Companies registered with the RBI under Section 3 of the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002.
To establish itself as an AIF, no entity or person shall act without obtaining a certificate of registration from the Securities and Exchange Board of India (SEBIApplication to the Board shall be made in Form-A in sub-regulation (4) as specified in the fifth schedule of the AIF Regulations. All category of AIFs as mentioned below shall furnish the following details as required by Form A of this Regulations-:
SEBI while granting registration to an AIF considers various factors which include:
1. The Memorandum of Association of companies, trusts, limited liability partnerships, proposed to be registered as AIFs shall permit them to carry the activity of an AIF.
2. Whether such proposed companies, trusts, Limited Liability Partnerships are duly registered with the required authorities.
3. The Applicant, sponsors, and managers are fit and proper persons, based on the criteria specified.
4. The Key investment management team including the manager and the sponsors have adequate experience, infrastructure and manpower to discharge the activities.
AIFs primarily seek and pitch in investments under three broad categories. All these categories are granted registration with the board on the same platform. The various categories under which registration can be granted are as follows:
They primarily invest in early start-ups and ventures which the government considers socially and economically viable and beneficial for the economy. The funds included in this category are Social Venture funds, SME Funds, Infrastructure Funds, and Venture Capital Funds. Investing in these funds bring a lot of benefits to the economy and support economic growth and development. The government generally provides concessions and incentives to these funds to promote a higher investment.
For example, CBDT clarified that income arising from the transfer of unlisted shares by Category I AIFs shall not be liable for taxation. Income from transfer of unlisted shares is being considered as capital gains and liable for taxation, a scenario which was seen as a hurdle earlier for foreign entities investing in country’s stock market. As per the existent regime income of the AIFs is not subject to tax at the AIF level.
Further, if Category I AIFs distribute income to the other Fund of Fund Investors which are themselves registered as AIFs there shall be no tax deducted at source.
Ease of doing Business is a major policy plank of the Government and its Application in the AIF sphere will help catalyse significant capital flows from both domestic and international investors.
Category II alternative investment funds are generally the Private Equity funds and the Debt funds which are not permitted to undertake leverage or borrowing other than to meet day to day operational requirements. No concessions and incentives are generally provided.
Category III Investment funds undertake high borrowings and leverage with a view to make short term gains by investing in listed or unlisted derivatives and are open-ended with no concessions and incentives. The hedge fund is an example of Category III AIF
|Serial No.||Particular||Category I AIF||Category II AIF||Category III AIF|
|01.||Registration||Form A specified under Sub Regulation(4), Schedule 5th of SEBI(AIF) Regulations, 2012||Form A specified under Sub Regulation(4), Schedule 5th of SEBI(AIF) Regulations, 2012||Form A specified under Sub Regulation(4), Schedule 5th of SEBI(AIF) Regulations, 2012|
|02.||Type of Funds||Angel Funds, SME Funds, Venture Capital Funds, Social Venture Funds, Infrastructure Funds||Private Equity and Debt Funds||Hedge Funds|
|03.||Effects on the Economy||Support Economic Growth and have positive spillover on the Economy||Less than the category I||Least, as the purpose is to make short term returns|
|04.||Concessions and Incentives by the Government||High in order to promote economic growth||No specific incentives and concessions are given||No specific incentives and concessions are given|
|05.||Leverage and Borrowing||No borrowing for the purpose of investment except for meeting temporary funding requirements for not more than thirty days, on not more than four occasions and for not more than ten percent of the investable funds||No borrowing other than to meet day to day operational requirements||Borrow for the purpose of an investment in listed or unlisted derivatives, gain from higher returns on investment than interest payments|
Different Types of Alternative Investment Funds
There are primarily eight types of AIFs defined under the SEBI (AIF) Regulations, 2012. Infrastructure Funds are generally those AIFs that invest in unlisted and listed debt or securitized debt instruments of the investee companies engaged in the purpose of operating, developing, and holding infrastructure projects. Debt funds are primarily involved in debt securities of the listed and unlisted companies. Social venture funds are registered primarily with the objective of providing social welfare and solving social issues prevalent in society. Hedge funds generally invest in derivatives for making short term gains.
The most common AIFs where domestic and foreign investment is solicited are Angel Funds, SME Funds, Venture Capital Funds, and Private Equity funds. Following is a comparative analysis of the conditions governing such investors as laid down in the SEBI (Alternative Investment Fund) Regulations, 2012.
|S. No.||Particulars||Angel Funds||Venture Capital Funds||SME Funds||Private Equity Funds|
|01.||Definition||Angel Funds are a sub-category of Venture Capital Fund under Category I which invest in venture capital undertakings involved in developing new products or services having a lock-in period of one year.1996||VC Funds primarily invest in unlisted securities of start-ups or early venture capital undertakings mainly involved in new products, services, new technology and work on new business models.||Such funds invest in unlisted securities of companies that are small and medium enterprises as governed by the Small and Medium Enterprises Develop-ment Act, or which are proposed to be listed on an SME Stock Exchange.||Funds that invest in equity and equity-linked investment of the investee companies.|
|02.||Purpose||They generally make small investments in the start-ups and have domain experience, however, might not have additional funds to follow on.||They invest in start-ups having high growth potential. They have the ability to do large deals, are highly networked and have the ability to follow on in future rounds||Invest in established or start-up Small and Medium Enterprises to promote such organizations.||Private Equity funds purchase large stakes in established businesses and take operational control of the investees.|
|03.||Category||Category 1 AIFs||Category 1 AIFs||Category 1 AIFs||Category II AIFs|
|04.||Concessions / Incentives from Government||1. The ‘Tax Pass Through status is available to the VCFs as per the provisions of 10(23FB) of the Income Tax Act, 1961 read with Section 115U of the Act, where taxes shall be levied at the hands of the investors and not funds.||Low/ No Concessions and incentives at all.|
|05.||Leverage and Borrowings||Don’t go for leverage and borrowings|
|06.||Material alteration to fund strategy||Consent of at least two-thirds of unit-holders required for material alteration.|
|07.||Raising of Funds||Shall raise funds only by way of issue of units to the angel investors. Foreign and Non-residents not covered.||May raise funds from any investor, whether Indian, Foreign or non-resident Indians by way of issue of units.
However, Funds raised from foreign are subject to the FDI Policy.
|08.||Corpus of the Funds||Each scheme shall have the corpus of at-least five crore Rupees.||Each scheme shall have a corpus of at-least twenty crore Rupees||Each scheme shall have a corpus of at-least twenty crore Rupees.||Each scheme shall have a corpus of at-least twenty crore Rupees.|
|09.||Minimum amount to be raised in the fund from each investor||Twenty-five lakhs||1 crore and above; However, in case of employees and directors of AIF or employees and directors of managers minimum value shall be Rupees twenty-five lakhs.|
|10.||Sponsor’s/ Manager’s Contribution||The sponsor or the manager shall have a continuing interest of not less than two and a half percent of the corpus or fifty lakh Rupees whichever is lower.||The sponsor or the / manager shall have a continuing interest of not less than two and a half percent of the corpus or five crore Rupees whichever is lower.||The sponsor or the / manager shall have a continuing interest of not less than two and a half percent of the corpus or five crore Rupees whichever is lower.||have a continuing interest of not less than two and a half percent of the corpus or five crore Rupees whichever is lower.|
|11.||Number of investors in each scheme||No scheme shall have more than 200 investors||No scheme shall have more than 1000 investors.||No scheme shall have more than 1000 investors||No scheme shall have more than 1000 investors|
|12.||Tenure of Schemes||Minimum tenure of three years. Tenure may be extended subject to the approval by 2/3 of the Unit holders by the value of their investment||Minimum tenure of three years. Tenure may be extended subject to the approval by 2/3 of the Unit holders by the value of their investment||Minimum tenure of three years. Tenure may be extended subject to the approval by 2/3 of the Unit holders by the value of their investment|
|13.||Investment in other AIFs||Angel funds can invest only in Angel funds belonging to category I.||Can invest only in Category 1 AIFs of the same sub-category. For example, a venture capital fund can only invest in a venture capital fund||Can invest only in Category 1 AIFs of the same sub-category. For example, a venture capital fund can only invest in a venture capital fund||Can invest in Units of Category I or Category II AIF|
|14.||Areas of Investment||1. Investment in Venture Capital Undertakings that complies with the eligibility criteria by the Department of Industrial Policy and promotion.
2. Ventures having a turnover of less than twenty-five crore Rupees.
3. Ventures that are not promoted by a common industrial group where turnover exceeds 300 crores.
4. Such companies or ventures shall not have any ‘family connection’ with any of the angels investing in the company.
5. Investment shall not be less than twenty-five lakhs and shall not exceed ten crore Rupees in venture capital undertakings.
|Venture Capital Undertakings, Special purpose vehicles, other units of AIF in Category I (of the same sub-category)
1. At least two-thirds of the investable funds shall be invested in unlisted equity shares or equity-linked instruments of a venture capital undertaking or in companies listed or proposed to be listed on an SME Exchange.
2.Not more than 1/3 shall be invested in:
a. Subscription to IPO of a Venture capital Undertaking.
b. debt or debt instrument of a venture capital undertaking
c. preferential allotment of equity shares of a listed company.
d. The equity shares of a financially weak company
|Venture Capital Undertakings, Special purpose vehicles, other units of AIF in Category I(of the same sub-category)
1. At least 75% shall be invested in unlisted securities of venture capital undertakings which are small and medium enterprises or in companies proposed to be listed on SME Exchange.
|Investment in unlisted investee companies or in the units of other AIFs.|
|15.||Restrictions on investment||Non-Banking Financial Companies, Gold Financing||Non-Banking Financial Companies, Gold Financing||Non-Banking Financial Companies, Gold Financing||No such restrictions.|
|16.||Limit on investment in one investee company||Shall not exceed 25% of the investable funds for all the schemes in single venture capital undertaking||Shall not exceed 25% of the investable funds in one investee company||Shall not exceed 25% of the investable funds in one investee company||Shall not exceed 25% of the investable funds in one investee company|
|17.||Listing||Units of the Angels are prohibited from listing on the stock exchange.||May be listed on stock exchange subject to a minimum tradable lot of one crore rupees||May be listed on stock exchange subject to a minimum tradable lot of one crore rupees||May be listed on stock exchange subject to a minimum tradable lot of one crore rupees|
|18.||Investment in associates||Angels are prohibited from investing in the associa-tes||Can be made subject to the approval of seventy-five percent of the value of their investment in AIF.||Can be made subject to the approval of seventy-five percent of the value of their investment in AIF.||Can be made subject to the approval of seventy-five percent of the value of their investment in AIF.|
|19.||Mode of raising funds||Through private placement by an issue of placement memoran-dum. However, a Term Sheet is filed with the SEBI prior to the launch of any scheme.||Through private placement by an issue of placement memorandum. The same placement Memoran-dum containing the details of the scheme is filed with the SEBI at least thirty days prior to the launch for seeking its comments.||Through private placement by an issue of placement memorandum.
The same placement Memoran-dum containing the details of the scheme is filed with the SEBI at least thirty days prior to the launch for seeking its comments.
|Through private placement by an issue of placement memo-randum.
The same placement Memoran-dum containing the details of the scheme is filed with the SEBI at least thirty days prior to the launch for seeking its comments.
|20.||Registration Fee with the SEBI||Rs.2,00,000||Rs.5,00,000||Rs.5,00,000||Rs.10,00,000|
|21.||Valuation of investments||Once in every six months by an independent valuer. Maybe enhanced to one year by approval of at least seventy-five percent of investors.||Once in every six months by an independent valuer. Maybe enhanced to one year by approval of at least seventy-five percent of investors.||Once in every six months by an independent valuer. Maybe enhanced to one year by approval of at least seventy-five percent of investors.|
Once the tenure of the AIFs or all the schemes launched by the AIFs are over, the funds set up as trusts, Limited Liability Partnerships, Companies, and Body Corporates shall wound up, and no further investments shall be made once all the communications regarding winding up have been made to the SEBI and the investors. Within one year of such intimations, the funds shall be distributed and all proceeds shall be disbursed to the investors after satisfying all the liabilities. The certificate of registration shall also be surrendered to the SEBI.
One burning issue in the governing of the AIFs is that venture capital funds are prohibited from investing in the NBFCs, and gold financing companies, which are causing practical hardships to the fin-tech venture capitalists. Fin-tech Venture Capitalists look for good avenues for investment to get good returns. For example a Venture Capital fund shall be restricted from being an ‘eligible lender’ under the Peer to Peer Lending Platform model which shall mandatorily be a Registered NBFC, governed by the RBI Provisions, thereby causing hardships to both the lenders and the investors. The same hardship applies to any gold financing companies. However, a normal Venture Capital Investor can invest directly in a Non-Banking Financial Company.
Thus having AIFs as alternate modes of investment can be a breakthrough for the investors and the organizations wherein executable ideas and exceptional talents of organizations get wings to fly.