How are New SEBI AIF Regulations Impacting Investment in Start-Ups?

Ankita Tiwari

23 May, 2024

India is one of fastest-growing economies in the world. India’s attractiveness has resulted in an inflow of foreign investments in India. To attract foreign investments, India has liberalized several laws to ease doing business in India. One such move by the Indian Government has been to curb the mis-selling of Alternate Investment Funds (AIF) to make them investment friendly. The Securities Exchange Board of India (SEBI) which is the securities market regulator has issued circulars time and again in furtherance to amendments in the SEBI (Alternate Investment Fund) Regulations, 2012 (SEBI (AIF) Regulations, 2012)^[1]. The purpose of the new AIF Regulations is to safeguard investor’s interests. The new AIF Regulations have been framed to bring more clarity, transparency and accountability to the start-up culture in India. All these frequent changes in the new AIF Regulations are only to ease the business of start-up stakeholders in India. This blog discusses the impact of new AIF Regulations introduced by SEBI.

Impact of New AIF Regulations 

1. SEBI inserted the definition of ‘start-up’ which means a private limited company or a limited liability partnership that aims to fulfil the criteria for a start-up. The insertion of the definition of start-up brought clarity and rationality to the meaning of start-up. It also reduced the compliance cost for providing different reports because of different rules.
2. SEBI amended the definition of Venture Capital Undertaking (VCUs) lifting the restrictions imposed in terms of services and activities thereby broadening the scope of VCUs. This amendment allowed Category I AIFs to invest in investee companies, VCUs, SPVs, LLPs, or units of other Category I AIFs in the same sub-category. This also means that now Category I AIFs will be allowed to invest in NBFCs.
3. SEBI has imposed restrictions that Category I & II AIFs cannot invest more than 25% of the investable funds in an Investee Company and Category III AIFs cannot invest more than 10% of the investable funds in an Investee company. This was a positive move to prevent a fund from over investing in one start-up resulting in the loss of principal for its investors. So this amendment ensures that the growing investor’s interest is protected.
4. A code of conduct has been introduced under the Fourth Schedule of SEBI (AIF) Regulation, 2012 for fund managers, investment committees, trustees, trustee companies and directors of each trustee company. The code of conduct aims to bring transparency and accountability.
5. By way of issuing a circular dated 23^rd November 2022, SEBI has adopted a scheme of priority distribution among investors. This circular restricts the sharing of loss by the sponsor/manager by providing that it shall not be less than pro rata to their holding in the AIF in relation to other unit holders. This change was brought as certain schemes were adopting a distribution waterfall in such a way that one class of investors shared more loss than pro rata to their holding in the AIF in relation to the other classes of investments or unit holders. This situation used to arise because the unit holders were given priority in distribution over one class of investors.
6. SEBI issued guidelines on the first close, calculation of tenure and change of sponsor/ manager or change in control of sponsor/manager by issuing a circular dated 17^th November 2022. The impact of the new Regulations issued vide this circular is that it provides certainty to the managers and sponsors in terms of tenure and timeline of the first closing. It will also ensure that the reorganization exercise of the sponsor and manager is effectively carried out.

• The impact of new AIF Regulations regarding the timeline for the declaration of the First Close of schemes of AIFs
  Earlier the SEBI (AIF) Regulations, 2012 did not provide the timeline for first close of the scheme. By way of this circular SEBI provides the timeline for first close of the scheme which is as follows:
  1. The First close of a scheme shall be declared within 12 months from date SEBI communicates taking Private Placement Memorandum (PPM) on record.
  2. For open-ended schemes of Category III AIFs, first close shall refer to the close of the Initial Offer Period.
  3. The Corpus of the scheme should not be less than minimum corpus prescribed in AIF Regulations for the respective category or sub-category of AIF.
  4. The commitment by the sponsor or manager at the time of declaration of the First Close shall not be reduced or withdrawn or transferred after the first close.
  5. Already existing schemes that have not declared the first close shall do so within 12 months from the date of the issue of this circular.
  6. Already existing schemes whose PPMs were taken on record 12 months before the date of this circular but have not declared their First Close shall submit their updated PPM with SEBI in the format prescribed by SEBI.
  7. Large Value for Accredited Investors (LVF) scheme shall declare their first close within 12 months from date of grant of registration of AIF or date of filing of PPM of a scheme with SEBI, whichever is later.
  8. All the existing LVFs shall declare their First Close within 12 months from date of issue of this circular.
  9. On failure to declare the first close of a scheme on time, the AIF shall file a fresh application for the launch of the said scheme as per the provisions of the SEBI (AIF) Regulations, 2012 by paying a requisite fee to SEBI.
     The impact of the new AIF Regulation will ensure that the AIFs are launched with PPMs that are not outdated due to the long gap between the submission of the PPM and the actual launch of the scheme. This regulation guides what constitutes a ‘launch’ of a new scheme that was not there earlier.
• The impact of new AIF Regulations regarding the calculation of tenure of close-ended schemes of AIFs
  The manner of calculating tenure of a close-ended scheme of an AIF has been formulated by SEBI as follows:
  1. The tenure shall be calculated from date of declaration of the First Close.
  2. The tenure of a scheme may be modified by the AIF before the declaration of the First Close. The investor may also withdraw or reduce the commitment provided in the scheme of AIF before the declaration of the First Close.
  3. Existing schemes of AIF which have already declared the First Close may calculate their tenure as per the previous circular. However, those schemes which have not declared a Final Close shall declare their Final Close as per timeline provided in the PPM of scheme and no discretion shall be provided to the AIF or the manager to extend the said timeline provided in PPM.
     The impact of new AIF Regulations willbe that it willensure the manager/sponsor does not commit a substantial amount only for achieving the minimum corpus. Managers/Sponsors have also been restricted from reducing, withdrawing or transferring the minimum corpus after First Close.
• The impact of new AIF Regulations regarding the change in control of manager/sponsor or change in manager/sponsor of AIFs:
  As per the new rules, change in control or change in sponsor/manager can take place with prior approval of SEBI along with payment of fees and any other condition as may be prescribed. The fee amount payable is equal to the registration fee applicable to that category of AIF and should be paid within 15 (fifteen) days from the date the proposed change in control or change in manager/sponsor came into effect. The impact of the new AIF Regulations will be that it will ensure that the manager and sponsors are eligible and satisfy the ‘fit and proper’ person criteria and that the new investment team satisfies the qualification and experience prescribed in the AIF Regulations.

SEBI issued another circular dated 9^th December 2022 regarding the manner of issue of funds from foreign investors. The circular prescribes that at the time of on-boarding foreign investors, the manager must ensure the following:

1. The foreign investor must be a resident of a country whose securities regulator is a signatory to International Organization of Securities Commission’s Multilateral MOU or has a bilateral MOU with SEBI; and
2. The foreign investor should not be on sanctions list notified by UN Security Council and should not be a resident of a country identified by Financial Action Task Force as having strategic anti-money laundering or terrorism financing deficiencies and has not taken any positive step in addressing the deficiencies.
3. In a situation where the investor has been on-boarded to AIF but subsequently fails to meet the above criteria, then as per SEBI mandate the manager of AIF should stop further capital contributions from such investors until they meet the requirements again.

The positive impact of the new AIF Regulations is that it will ensure the investors do not fall within the grey list. However, the negative impact of this would be that the grey list is updated thrice every year so it will create uncertainty among the fund managers when it comes to complying with these new AIF Regulations and will restrict their flexibility. 

Conclusion

These amendments in the AIFs Regulations and issuance of new Circulars are attempts made by SEBI to promote the growth of the AIF Industry while also maintaining adequate regulatory oversight. These regulations also intend to protect the interest of the investors. Therefore, the impact of new AIF Regulations is expected to be mostly positive. 

Also Read: SEBI Issues Guidelines for AIFs for Declaration of First Close of Scheme