Upon requests from Alternative Investment Funds (AIF) industry associations, Securities and Exchange Board of India (SEBI) in its consultation paper dated November 13, 2024 (Consultation Paper) proposes to streamline the regulatory framework governing angel funds under SEBI (Alternative Investment Funds) Regulations, 2012 (AIF Regulations) to: (a) rationalize their fundraising processes; (b) strengthen disclosure and governance requirements; (c) provide operational clarity and investment flexibility; and (d) restrict angel funds to investors with commensurate risk appetite. The Consultation Paper also questions if angel funds should be regulated under AIF Regulations following the abolishment of angel tax.

 

The proposals and recommendations made under the Consultation Paper are as follows:

 

  • Following the recommendations of SEBI’s Alternative Investment Policy Advisory Committee (AIPAC), SEBI proposes to continue with maintaining angel funds as a regulated structure as they are important in professionally managing angel investor’s capital and play a critical role in funding start-ups.

 

  • For investor eligibility, considering the need to ensure onboarding of only investors with appropriate risk appetite and understanding of risk, SEBI proposes to only allow accredited investors to invest in angel funds. These accredited investors have to meet the net worth criteria and undergo verification by third party accreditation agency. However, there will be no change in the criteria that the number of investors contributing to investment in a particular investee company shall not exceed 200 during a financial year, excluding qualified institutional buyers. Additionally, employees, directors and advisors of angel funds and their managers should be allowed to invest with a minimum investment amount of INR five lakhs to enhance their ‘skin in the game’.

 

  • Further, SEBI has proposed to remove Regulation 19(D)(3) and Regulation 19(D)(2) of AIF Regulations which specify the commitment period for angel investors and minimum corpus amount for angel funds respectively. Under the current framework of Regulation 19(D)(3), an angel fund shall accept not less than INR 25 lakhs from angel investors, up to a maximum period of five years (Commitment Period). The aim to remove the Commitment Period is that five years may not be sufficient period to fully drawdown on an investor’s capital. Additionally, the minimum corpus requirement of INR five crores is proposed to be replaced with requirement that angel funds need to investment only after on-boarding minimum five accredited investors. Therefore, making the ‘corpus criteria’ irrelevant. Accordingly, all existing conditions linked to corpus/investable funds, shall instead be linked to the total investments by angel funds.

 

  • Due to the growth in angel ecosystem and growing interest in angel investments as an investment class, investments by an angel fund in any start-up is proposed to be between INR 10 lakhs to INR 25 crores, revised from the current framework of INR 25 lakhs to INR 10 crores. Additionally, the current 25% diversification limit (which prevents schemes from investing more than 25% of total investments in a single venture capital undertaking) under Regulation 19F(5), is proposed to be removed since adherence to this limit has neither been feasible and nor is easily verifiable by the regulator, especially now, that only accredited investors will be permitted to invest. However, each investment shall require contribution from minimum three accredited investors (excluding manager/sponsor) to prevent angel funds becoming single-investor structures. In the case of investments in group companies or related parties of existing investee companies, specific disclosures to investors shall be mandatory at the time of obtaining their consent to invest.

 

  • Currently, angel funds can only invest in companies recognized as ‘start ups’. This prevents angel funds from exercising pre-emption rights in portfolio companies which are no longer considered as start-ups. Therefore, recognizing the need to protect existing investments, angel funds may be permitted to make follow-on investments in portfolio companies even if they no longer qualify as start-ups. However, this flexibility comes with specific conditions. Contributions will only be accepted from investors who invested when the company was a start-up, and only to the extent that post-issue beneficial interest doesn’t exceed prior holdings. The follow-on investment shall comply with the maximum limit of INR 25 Additionally, the lock-in requirement for investments by angel funds is proposed to be reduced to six months instead of one year.

 

  • To ensure fair and equal treatment of investors, each investment opportunity must be offered to all investors of the angel fund, with allocation methodology explicitly disclosed in the private placement memorandum (PPM). The proposal mandates that such methodology be objective and not provide blanket discretion to the manager to decide allotments on case to case basis and remove any preferential treatment. Investors shall have rights in investments and distribution of proceeds pro-rata to their contribution in each investment.

 

  • The sponsor/manager shall maintain minimum continuing interest of 0.5% of investment amount or INR one lakhs whichever is higher, in each investment of angel fund instead of continuing interest of at least 2.5% of corpus, or INR 50 lakh, whichever is lesser under the extant regulations. It is proposed that the continuing interest will be maintained at each investment rather than at fund level, ensuring sponsor / manager have an interest in every individual deal.

 

  • To standardize and enhance transparency in disclosure, SEBI proposes prescribing template PPM for angel funds by modifying the existing template for Category I AIFs. The proposals further mandate merchant bankers to file PPMs with SEBI and PPM audit for angel funds having total investments exceeding INR 100 crores. It is also proposed that angel funds must conduct their first close within 12 months from SEBI’s acknowledgment of PPM by on-boarding minimum five accredited investors instead of being not subject to any first-close timeline requirements.

 

  • The Consultation Paper further proposes to bring angel funds under the mandate for performance benchmarking to help investors assess performance of angel fund sub-category. It also proposes retaining the existing prohibition on listing of units of angel funds. The proposal aims to adopt a structure implementation approach for new angel funds where all conditions shall apply from the notification date of amended regulation whereas, existing angel funds shall receive a one year transition period.

 

Conclusion:

 

The Consultation Paper proposes to strengthen the regulatory framework of angel funds by enhancing fund raising process, governance, and ensuring investor protection, while providing operational clarity post abolishment of angel tax. The proposal, if implemented, will broaden the regulatory framework governing angel funds and enhance their ease of doing business.

Authors & Contributors

Partner(s):

Dhruv Chatterjee

 

 

Associate:

Prachi Yadav
Ridima Gupta