SEBI’s Informal Guidance Regarding Angel Fund Operational Challenges Under AIF Regulations
This article deals with a recent interpretive letter issued by the Securities and Exchange Board of India (SEBI) under its Informal Guidance Scheme, 2003.[1] The letter addresses operational challenges faced by FirstPort Capital Angel Fund, a SEBI-registered Category I Venture Capital Fund – Angel Fund, concerning the provisions of the Securities and Exchange Board of India (Alternative Investment Funds) Regulations, 2012 (AIF Regulations). This analysis will dissect the queries raised by the Fund and SEBI’s corresponding responses, providing clarity on key regulatory aspects for angel funds in India.
Table of Contents
Background: FirstPort Capital’s Queries
FirstPort Capital Angel Fund sought informal guidance from SEBI on six specific operational issues encountered while functioning as an Angel Fund. These queries touched upon crucial aspects of AIF Regulations concerning investment eligibility, investment limits, exit opportunities, capital commitments, and investor eligibility.
SEBI’s Interpretations and Analysis
SEBI addressed each query, providing its interpretation of the relevant AIF Regulations.
Investment in Start-ups Losing Eligibility
The first question related to a situation where an Angel Fund had invested in a start-up which was initially eligible as per the DPIIT notification issued on January 16, 2019. Later, this investee firm fell short of such criteria.
The Fund requested confirmation as to whether it was still able to exercise its pre-emptive rights, rights issue, or renounced rights issue of shares in respect of convertible securities, in accordance with the shareholders’ agreement made at the time of initial investment, by subscribing to the capital being issued. SEBI responded by making it clear that according to Regulation 19F(1) of the AIF Regulations, Angel Funds are specifically required to invest in start-ups satisfying the conditions stipulated in Regulation 2(1)(wa) of the same regulations.
Therefore, the current AIF Regulations do not allow for investments by the Angel Funds in firms that are no longer categorized as start-ups. Hence, SEBI expressed the view that investments by Angel Funds, by exercising pre-emptive rights, in their current portfolio companies which are no longer start-ups would not be in consonance with the AIF Regulations.
Minimum Investment Amount for Subsequent Investments:
The second query pertained to the minimum investment amount stipulated for Angel Funds. Specifically, the Fund inquired whether the limit of INR 25 Lakh, as mentioned in Regulation 19F(2), would be separately applicable for any subsequent investments made after the original investment in the same investee company, or if this limit applied solely to the initial or first investment.
SEBI clarified that as per Regulation 19F(2) of the AIF Regulations, the minimum amount an Angel Fund must invest in a start-up is INR 25 Lakhs. However, SEBI explicitly stated that this requirement of a minimum investment amount would not apply to any additional or follow-on investments made by the Angel Fund in its existing portfolio investee company or start-up.
Partial Exit Opportunities and Pro-rata Redemption:
The third and fourth queries raised by FirstPort Capital Angel Fund related to a situation where the Fund had received an opportunity for a partial exit from a Strategic Contributor facilitated by the Investee Company. The contributions were offered to exit on a pro-rata basis from the given investment scheme. In some instances, certain contributors preferred to liquidate more than their proportionate entitlement or total holding, while others wished to liquidate less than their entitlement or even none at all. In this scenario, the Fund sought guidance on whether the units should be redeemed pro-rata to the contribution made by each investor or based on the number of units each investor desired to redeem.
SEBI, however, invoked paragraph 8 of the SEBI (Informal Guidance) Scheme, 2003, which allows SEBI to not respond to requests where policy concerns necessitate such a stance. Consequently, SEBI did not provide any specific response to these queries, indicating that these matters likely involve broader policy considerations beyond the scope of informal guidance.
Impact of Unit Transfers on Capital Commitment
The fifth query covered the effects of unit transfers among contributors to their minimum commitment of capital. The Fund sought to know whether a decrease in the commitment value due to unit transfers, according to the Master Memorandum and Contribution Agreement terms (except for redemptions), would qualify as a shortfall in the minimum capital commitment of the transferor under their respective Contribution Agreement. In addition, they asked if the transferor would be required to recover this possible deficit. With respect to the transferee, the question asked if the transferred units would be part of the transferee’s minimum capital commitment or if the value of such units would be added to their already committed minimum capital commitment amount.
In addition, the Fund requested clarification as to whether the fees, costs, and expenses due to the Fund would be part of the amount of capital contribution committed by the contributor or investor pursuant to the contribution agreement. In turn, SEBI invoked Regulation 19D(3) of the AIF Regulations, which provides that Angel funds shall accept, within a maximum period of five years, an investment of at least INR 25 lakh from an angel investor. SEBI also referred to Regulation 2(1)(p), which states “investable funds” as corpus less estimated administration and management charges for the fund period, and Regulation 2(1)(h), which states “corpus” as aggregate of money invested by the investors through a written contract.
Following these definitions, SEBI expressed that corpus of the Angel fund, defined, would comprise the aggregate amount of funds committed by the investor through an agreement in writing, and hence, the amount committed as capital by an investor may be including the fees, costs, and expenses to be paid to the Fund. While SEBI’s response clarifies the inclusion of fees in the capital commitment, it does not explicitly address the implications of unit transfers on the minimum capital commitment of the transferor and transferee. However, the definition of corpus suggests that the committed capital remains within the Fund regardless of the unit holder until a formal redemption occurs.
Eligibility of Trusts as Angel Investors
The last query asked for clarification regarding whether the expression “body corporate” in the definition of “Angel Investor” under Regulation 19A(2) includes trusts, and if included, on what criteria would a trust be on-boarded as an Angel Investor. SEBI had recourse to Regulation 2(2) of the AIF Regulations, which says that undefined terms shall mean as defined under the Act, the Securities Contracts (Regulation) Act, 1956, or the Companies Act, 2013.
SEBI had recourse to Section 2(11) of the Companies Act, which defines “body corporate” but clearly excludes cooperative societies and any other body corporate (not being a company) the Central Government might specify. Based on this, SEBI concluded that in terms of Regulation 19A(2)(b) of the AIF Regulations, a trust cannot be an angel investor in an angel fund unless it is registered as an AIF under the AIF Regulations or as a Venture Capital Fund under the SEBI (Venture Capital Funds) Regulations, 1996.
Conclusion
SEBI’s informal guidance to FirstPort Capital Angel Fund offers valuable insights into the regulator’s interpretation of specific provisions within the AIF Regulations concerning angel funds. The clarification on investment eligibility post-start-up status and the minimum investment amount for subsequent rounds provides crucial operational clarity.
While SEBI refrained from commenting on the intricacies of partial exit mechanisms, its stance on capital commitment including fees and the ineligibility of unregistered trusts as angel investors further strengthens the understanding of the regulatory framework governing angel funds in India. This interpretive letter underscores SEBI’s role in addressing practical challenges faced by AIFs and promoting a clearer understanding of the regulatory landscape.
[1] https://www.sebi.gov.in/sebi_data/commondocs/mar-2025/13.03.25_Informal%20guidance%20letter%20by%20SEBI_p.pdf.
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