India’s startup ecosystem has emerged as a global powerhouse, fueled by innovation, technological advancements, and a dynamic entrepreneurial spirit. To advance this innovative spirit, early stage and developing startups require expertise and funds from industry experts. According to SEBI (Alternative Investment Funds) Regulations, 2012, which primarily governs the venture capital undertaking, the term can be defined as such –
“2(1)(z) Venture capital fund means an Alternative Investment Fund which invests primarily in unlisted securities of startups, emerging or early-stage venture capital undertakings mainly involved in new products, new services, technology or intellectual property right based activities or a new business model and shall include an angel fund as defined under Chapter III-A.”
To better understand the abovementioned definition, it is important to remember S. 2(1)(b) of the Regulations which define Alternative Investment Funds as any fund:
1. Established or incorporated in India;
2. Can be a trust/ company/ limited liability partnership/ body corporate;
3. Which is a privately pooled vehicle that collects Indian or foreign funds for investing;
4. Not covered under Mutual Fund Regulations, Collective Investment Schemes Regulations or any other regulations;
5. Does not include: family trusts, ESOP trusts, employee welfare trusts or gratuity trust, holding companies, other special purpose vehicles, funds managed by reconstruction or securitization companies under SARFAESI Act.
As per a Business Standard article, the venture capital sector in India between January and November 2024 recorded a total value of $16.77 billion across 888 deals, a 14.1 per cent increase in value and a 21.8 per cent rise in deal count. The technology sector was the key driver of the industry.
Any company looking to enter the venture capital industry needs to have a firm grasp over the provisions of these regulations. This article will provide you with a basic framework to poise you for your first equity deal.
Important Provisions
1. Categories of Alternative Investment Funds (Regulation 3): AIFs are supposed to obtain registration under the Regulations the process for which is given in this clause. For this purpose, they are classified into three categories:
· Category I: Funds that invest in socially or economically desirable projects such as infrastructure, SMEs, and social ventures. These receive government and SEBI incentives.
· Category II: Private equity funds and debt funds that do not leverage or borrow except for operational purposes.
· Category III: Hedge funds and other funds that engage in diverse or complex trading strategies, including leverage.
2. Eligibility Criteria (Regulation 4): All AIFs must be setup under the proper applicable laws which are mentioned under this clause. Furthermore, the applicant must comply with the fit-and-proper criteria. This clause also provides the requirements for key investment team of the Manager of an AIF.
3. Investment Strategy (Regulation 9): All AIFs shall state investment strategy, investment purpose and its investment methodology in its placement memorandum to the investors. Any material alteration to the strategy shall be made with the consent of atleast two thirds of unitholders by value of their investment in the AIF.
4. Minimum Corpus and Investment Limits (Regulation 10 & 19): The minimum corpus of an AIF must be INR 20 crore and the minimum investment by an investor must be INR 1 crore, except for employees or directors of the fund, who can invest a minimum of INR 25 lakh.
5. Sponsor Commitment (Regulation 10(d)): The sponsor or manager of an AIF must contribute a certain percentage of the fund corpus:
- Category I and II: At least 2.5% of the corpus or INR 5 crore, whichever is lower.
- Category III: At least 5% of the corpus or INR 10 crore, whichever is lower.
6. Leverage and Borrowing Restrictions (Regulation 15(2)):
· Category I and II AIFs are prohibited from leveraging except for temporary funding needs.
· Category III AIFs are permitted to leverage within limits prescribed by SEBI.
7. General Investment Conditions (Regulation 16, 17, and 18):
· Category I and II AIFs: Cannot invest more than 25% of their corpus in a single investee company.
· Category III AIFs: Can invest in listed or unlisted securities but must adhere to limits set by SEBI to avoid systemic risks.
· AIFs cannot raise funds via public solicitation. Investments must be privately placed.
8. Reporting and Disclosure Obligations (Regulation 20 & 22): AIFs must submit quarterly reports to SEBI, detailing financial statements, investment portfolio, and risk assessments. Disclosure of fees, risks, and conflicts of interest must be made to investors.
9. Valuation Requirements (Regulation 23): AIFs must ensure the valuation of investments is carried out by an independent and qualified valuer. This is mandatory at least annually or as specified by SEBI.
10. Report & Records (Regulation 27 & 28): The Manager or Sponsor shall be required to maintain records about the assets under the scheme/fund, valuation policies and practices, investment strategies, particulars of investors and their contribution, and rationale for investments made. Furthermore, the Board may at any time call upon the Alternative Investment Fund to file such reports, as the Board may desire, with respect to the activities carried on by the Alternative Investment Fund
11. Winding-Up of AIFs (Regulation 29): AIFs can be wound up after the tenure of the fund expires or by majority consent of investors. AIFs must provide an audit report and distribute the remaining assets among investors in a timely manner.
Conclusion
There are a lot of technicalities in the AIF Regulations which was further extended by the latest amendments made in November 2024. This can be overwhelming for new VC funds. However, we believe that this article will give you a general idea about the Regulations and understand where to start.