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Alternative Investment Funds (AIFs) in India

Introduction

An AIF means any fund established or incorporated in India in the form of a trust or a company or a LLP or a body corporate which:

  1. Is a privately pooled investment whether Indian or foreign. It basically collects the funds from the investors, for investing in accordance with a defined investment policy for the benefits of investors;
  1. Does not come within the purview of Securities and Exchange Board of India (Mutual Funds) Regulations, 1996, Securities and Exchange Board of India (Collective investment schemes) Regulations, 1999 or the other regulations of the Board for regulating the fund management activities.

 

The eligibility criteria/conditions are as follows:

  • Investors can be Indian, NRI or foreign. However, for angel funds, Investors should be angel investors only;
  • Minimum corpus should be Rs. 20 Crores (USD 3,080,000.00) for each scheme and Rs. 10 Crores (USD 1,540,000.00) for angel funds;
  • Minimum investment by each investor should be Rs. 1 Crore (USD 154 ,000. 00 ), or Rs. 25 Lakhs (USD 38,500.00) (in case of employees/directors/fund manager of AIF or angel investors), as applicable. There are however no minimum investment requirement on units of AIF issued to the employees of the manager for profit sharing;
  • Maximum number of investors can be 1000 for each scheme and 49 in case of angel funds. However, the industry demand is to bring up the number to 200, in case of angel funds, in parity with the private placement provisions under the Companies Act, 2013;

 

The below mentioned trusts/companies/funds are excluded from the purview of Alternative Investment Funds, subject to the above conditions:

  1. The family trusts
  2. ESOP trusts
  3. Employee welfare trust
  4. Holding companies within the meaning of section 4 of the Companies Act, 2013
  5. Other Special Purpose Vehicle which are not established by the fund managers including the securitization trusts, regulated under a specific regulatory framework
  6. Funds which are managed by the registered securitization company or the reconstruction company
  7. Any pool which is regulated by the other Indian regulator.

 

Classification of AIF

SEBI has classified AIF into the following categories:

  1. Category I AIF:  Category I AIFs are funds which are having the strategy to invest in start-up or early stage ventures or social ventures or SMEs or infrastructure or other sectors or areas which the government or regulators consider it as socially or economically desirable.

    Under the AIF Regulations, there are various funds which are elected as sub-categories of Category IAIFs - venture capital funds, SME funds, social venture funds, infrastructure funds and the other AIFs as may be specified. SEBI has introduced ‘angel investment funds’ in September 2003 which is considered as a sub class of the venture capital fund sub-category.
  1. Category II AIF: Category II AIFs are funds which cannot be considered as Category I AIFs or Category III AIFs. These funds do not undertake leverage or borrowing other than to meet day-today operational requirements and as permitted in the AIF Regulations.

    AIFs such as private equity funds or debt funds for which no specific incentives or concessions are given by the Government of India or any other regulator that are included in the Category II AIF classification.
  1. Category III AIF: Category III AIFs are the funds which employ complex or diverse trading strategies and may employ leverage through investment in listed or unlisted derivatives.

    AIFs such as hedge funds or funds which trade with a view to make short-term returns or such other funds which are open ended and for which there is no specific incentives or concessions are given by the Government of India or any other regulator that are included in the Category III AIF classification.

 

Registration of AIF

  1. All AIFs are required to be registered under any one of the above mentioned categories. The application for the grant of certificate shall be made in Form A as specified along with the non-refundable application fee.  On receipt of the application and registration fee as specified, the Board shall grant a certificate of registration in Form B.
  1. AIF Regulations sanction the launch of multiple schemes under an AIF without having the separate registration from SEBI subject to filing of Information Memorandum with SEBI.
  1. The certificate of registration, once granted, shall be valid till the concerned AIF is wound up.

 

Conditions for Investment and restrictions applicable to all categories of AIFs

  1. Investment approach
    AIF can raise funds by way of private placement by the issue of Information Memorandum. AIF will be required to state its purpose for investment, investment strategy and business model in the Information Memorandum to investors. Any material change in the fund strategy shall need to get the consent of at least two-thirds of unit holders by value.
     
  1. Continuing Interest
    The AIF Regulations require the sponsor or the manager of an AIF to make contribution of a certain amount of capital to the fund. This portion is termed as the continuing interest and will remain locked-in the fund till the distributions have not been made to the other investors in the fund.

    For a Category I or Category II AIF, the sponsor or the manager is required to have a continuing interest of 2.5% of the corpus of the fund or INR 5 crores (USD 770,000.00) whichever is low and in case of a Category – III AIF, a continuing interest of 5% of the corpus or INR 10 crores (USD 1,540,000.00) whichever is low.

    For the newly introduced angel investment funds, the AIF Regulations require the sponsor or the manager so as to have a continuing interest of 2.5% of the corpus of the fund or INR 50 lakh (USD 77,000.00) whichever is low. Further, the sponsor or the manager has to disclose their investment to the investors of the AIF.
     
  1. Minimum Corpus
    The AIF Regulations lays down that the minimum corpus for any AIF shall be INR 20 crores (USD 3,080,000.00) (“Minimum Corpus”). Corpus is considered to be the total amount of funds committed by investors to the fund through written contract or any such document as on a specified date. By its circular dated on June 19,2014, SEBI requires that where the corpus of an open-ended scheme falls below the Minimum Corpus (post redemption(s) by investors or exits), the fund manager is required to be given a period of three months to restore the Minimum Corpus, failing which, all the interests of the investors are required to be mandatorily redeemed.
     
  1. Minimum Investment
    The AIF Regulations do not allow an AIF to accept an investment less than INR 1 crore (USD 154,000.00) (“Minimum Investment Amount”) from any investor unless such investor is an employee or a director of the AIF or an employee or director of the manager of the AIF in which case the AIF can accept investments of a minimum value of INR 25 lakh (USD 38,500.00). The Circular has mentioned that in case of an open-ended AIF, the first lump-sum investment received from an investor should not be less than the Minimum Investment Amount. In Addition to this, in case of partial redemption of units by an investor in an open-ended AIF, the amount of investment retained by the investor should not fall below the Minimum Investment Amount.
     
  1. Qualified Investors
    The AIF Regulations allow an AIF to raise funds from any investor whether Indian, foreign or non-resident by way of issue of units of the AIF. By accepting the investments from non-resident investors requires the approval from the FIPB.
     
  1. Maximum Number of Investors
    The AIF Regulations caps the maximum number of investors for an AIF at 1,000.
     
  1. Private Placement
    The AIF Regulations require that no AIF should seek or collect funds except through private placement. While the AIF Regulations do not lay down any thresholds or rules for private placement, guidance is taken from Companies Act, 1956 (and the recently introduced Companies Act, 2013).
     
  1. Tenure
    Though the Category I and Category II AIFs can only be closed-end funds, Category III AIFs can be open ended. The AIF Regulations lays down the minimum tenure of three years for Category I and Category II AIFs. The tenure of any AIF can be extended only with an approval of two-third of the unit-holders by value of their investment in the AIF.
     
  1. Liquidity Facility
    The Circular provides that in case of any ‘material change’ (i.e., changes that SEBI believes to be significant enough to influence the decision of the investor to continue to be invested in the AIF to the placement memorandum is said to have arisen in the event of (1) change in sponsor / manager, (2)change in control of sponsor / manager, (3) change in fee structure which may result in higher fees which is being charged to the unit holders and (4) change in fee structure or hurdle rate which may result in higher fees being charged to the unit holders, the existing investor who does not wish to continue post the change shall be provided with an exit option and such existing investors will be provided not less than one month for indicating their dissent.

 

Reporting

Alternative Investment Fund shall provide at least on an annual basis, within the period of 180 days from the year end, reports to investors including the following information, as may be applicable to the Alternative Investment Fund:

  1. Financial information of the investee companies.
  2. Material risks and how these risks are managed which may include:
    1. concentration risk at fund level
    2. foreign exchange risk at fund level
    3. leverage risk at fund and investee company levels
    4. realization risk (i.e. change in exit environment) at fund and investee company levels
    5. strategy risk (i.e. change in or divergence from business strategy) at investee company level
    6. reputation risk at investee company level
    7. extra financial risks, including environmental, social and corporate governance risks, at fund and investee company level.

Category III Alternative Investment Fund shall provide quarterly reports to investors within the period of 60 days at the end of the quarter

 

Valuation

Category I and Category II Alternative Investment Funds shall undertake the valuation of their investments, at least once in every six months, by an independent valuer appointed by the Alternative Investment Fund. Such period may be extended to one year on approval of at least seventy five percent of the investors by value of their investment in the Alternative Investment Fund.

Category III Alternative Investment Funds shall make sure that the calculation of the net asset value (NAV) is independent from the fund management function of the Alternative Investment Fund and such NAV shall be disclosed to the investors at the intervals which is not longer than a quarter for close ended Funds and at intervals not longer than a month for open ended funds.

Gautam Khurana
28 November 2017

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