Alternate Investment Fund Category I Regulations

Ankita Tiwari

06 Apr, 2023

Alternate Investment Funds (AIFs) are non-conventional investment avenues. They comprise pooled investment funds which invest in venture capital, private equity, hedge funds, etc. AIFs can establish themselves in the form of a company, trust, LLP, or body corporate. There is a separate set of regulations that deal with AIFs. Major regulation pertaining to AIFs is the Securities Exchange Board of India (Alternate Investment Funds) Regulations, 2012. This regulation prescribes three categories of AIFs, namely:
Category I
Category II, and
Category III.

These categories further cover different types of investments. In this blog, we will specifically discuss Category I AIF investments.

As per the SEBI (AIF) Regulations, 2012^[1], Category I AIF covers investments in Start-ups, early-stage ventures, SMEs, or social ventures or infrastructure or other sectors that are socially or economically viable as per the government and regulatory body. These investments have high growth potential. The Government and the regulators provide incentives and concessions to Category I AIF as they have a compounding effect in terms of growth and job creation. When Category I AIF came into effect, it served as a lifesaver for the already existing start-ups starving for capital.

Category I AIF investments are of the following types:

• Venture Capital Fund
• Small to Medium Enterprises Fund (SME Fund)
• Infrastructure Fund
• Angel Fund
• Social Venture Fund
• Special Situation Fund
• Any other Fund as may be prescribed by SEBI from time to time

Let’s discuss each type of Category I AIF investment in detail:

1. Venture Capital Fund
   Venture Capital Fund (VCFs) is a type of Category I AIF investment that pools money from investors to make equity investments in multiple start-ups as per their business profiles, asset size, and state of product development. In return, the investor gets a share in the business in which the VCF has invested its money. VCFs are high risks and high returns investment options which are generally preferred by High Net-Worth Investors (HNIs). After the inclusion of VCFs under AIFs, the non-resident HNIs can also invest in VCFs. Earlier VCFs were registered under the SEBI (Venture Capital Funds) Regulations, 1996 but it has been subsumed by the SEBI (AIF) Regulations, 2012. VCFs focus on early-stage investments so they are different from mutual funds and hedge funds.
2. Small to Medium Enterprises Fund (SME Fund)
   As the name suggests this type of fund invests in SMEs whether listed or unlisted and meets their debt capital requirement through NBFCs. SME Fund requires a minimum investment of Rs. 1 crore with a minimum lock-in period of 3 years with an additional extension option of 2 years. Further, to be classified as a Category I AIF, they have to invest a minimum of 75% of the assets in listed or proposed to be listed or unlisted SME companies. As this investment have high-risk and high returns, HNIs who can take aggressive risks should invest in these funds.
3. Infrastructure Fund
   This type of Category I AIF invests in the development of public assets like roadways, railways, airports, etc. Only those investors who are confident about the rise in share prices in the coming times should invest in this type of fund as these sectors have high entry barriers and low competition. Returns from infrastructure investment can be in the form of capital growth and dividend income. In some socially and economically desirable projects, the Government or the regulators extend tax benefits on such investments.
4. Angel Fund
   Angel Fund is a sub-category of VCF under Category I AIF. Angel Fund raises funds from angel investors. Angel Investors are HNIs who propose to invest in angel funds. All angel funds or schemes should comply with Chapter III-A of the SEBI (AIF) Regulations, 2012. The following conditions are to be satisfied to be an angel investor:
   • Individuals who have net tangible assets of two crore rupees or more excluding the value of their principal residence and have early-stage investment experience or experience as serial entrepreneurs or a senior management professional with a minimum of 10 (ten) years of experience.
   • A body corporate has a net worth of a minimum of 10(ten) crore.
   • An AIF registered under the SEBI (AIF) Regulations, 2012, or a Venture Capital Fund registered under the predecessor law i.e; the SEBI (Venture Capital Funds) Regulations, 1996. 
     Angel Fund raises funds by issue of units to angel investors through private placement by the issue of an information memorandum or placement memorandum. An Angel Fund should have a corpus of not less than 5 (five) crore rupees and should accept an investment of not less than 25 (twenty-five) lakh rupees from an angel investor up to a maximum period of 5(five) years. Angel Fund cannot have more than 200 (two Hundred) angel investors. If an Angel Fund is established as a Company, then the provisions of the Companies Act, 2013 will also be applicable. Angel Fund invests in start-ups not promoted or sponsored by or related to an industrial group having a group turnover of more than 300 crore rupees and should not be companies with family connections with any angel investor. Angel Fund Investment in venture capital undertaking should range from 25 (twenty-five) lakh rupees to 10 (ten) crore rupees and should be for a lock-in period of 1 (one) year. In addition, angel funds should not invest more than 25% of the total investments in one venture capital undertaking. Angel Fund can also invest in securities of companies incorporated abroad by complying with the conditions and guidelines issued by the SEBI or RBI from time to time. However, Angel Funds are prohibited from being listed on any recognized stock exchange.
5. Social Venture Fund (SVF)
   Social Venture Funds are those funds that invest in companies that are inclined towards bringing a change in society. SVFs focus on solving social and environmental issues and making profits simultaneously. SVFs are mainly associated with non-profit making entities such as charitable trusts, societies, etc. SVFs are at least 75% of their corpus in unlisted securities or partnerships of social ventures satisfying social performance norms. SVFs may also accept from or give grants to social ventures and may also accept restricted or muted returns. Investors investing in SVFs can expect to make a profit as social ventures are gaining dominance and have great potential for growth outside developing countries.
6. Special Security Fund
   This type of Category I AIF invests in special situation assets in accordance with its investment objectives and can also act as a resolution applicant under the IBC, 2016. Special Situation Asset include stressed loan available for acquisition as per Clause 58 of the Master Directions- Reserve Bank of India (Transfer of Loan Exposures) Directions, 2021 or is included in a resolution plan approved under IBC, 2016 or as per any other policy of the Government of India; or security receipts of an Asset Reconstruction Company registered with the RBI; or securities of investee companies; or any other asset as may be prescribed by SEBI from time to time. Special Situation Funds shall function as per the norms laid down by SEBI.

Conclusion

AIFs provide greater return, flexibility and scope as compared to conventional assets. Talking about Category I AIFs, are strategic investments in start-ups, early-stage ventures, social ventures, socially and economically viable sectors, etc. This kind of investment makes diversification easier due to the market strategies and investment styles and reduces the volatility due to their non-dependency on stock market fluctuations thus having a strong potential for growth.

Also Read:
Categories of Alternative Investment Funds