Consultation Paper On Review Of Regulatory Framework For Angel Funds In AIF Regulations

Angel Funds are a cornerstone of the startup ecosystem, providing crucial early-stage capital to innovative ventures. By fueling entrepreneurship, these funds drive economic growth, foster innovation, and play a key role in nurturing businesses at their nascent stages. Recognizing their importance, India has undertaken significant regulatory reforms, most notably the abolition of the Angel Tax, to further incentivize investments in startups and create a more supportive environment for Angel Investors.

SEBI’s latest consultation paper outlines a series of proposed changes to the regulatory framework for Angel Funds, aimed at balancing flexibility, transparency, and investor protection.[1] These proposals reflect the evolving needs of the angel investment ecosystem and seek to address operational gaps while streamlining compliance requirements for Angel Funds.

The Proposals

1. Accredited Investors as Participants

A central focus of the proposals is ensuring that only Accredited Investors with verified net worth and financial expertise can participate in Angel Funds. This measure aims to protect less-informed investors while attracting individuals and entities with a demonstrated capacity to understand and absorb the inherent risks of early-stage investments. To achieve this, SEBI proposes revising eligibility criteria for Angel Investors and introducing stringent verification processes for onboarding.

2. Removing Minimum Corpus Requirements

The current requirement for Angel Funds to maintain a minimum corpus is proposed to be removed, offering greater flexibility in fund operations. However, safeguards such as requiring a minimum of five Accredited Investors before commencing investments will ensure that Angel Funds maintain a viable investor base.

3. Revising Investment Limits

To better align with the growth and diversity of the angel investment ecosystem, the paper proposes reducing the minimum investment limit in startups to ₹10 lakh and increasing the maximum limit to ₹25 crore. This adjustment allows Angel Funds to cater to a broader spectrum of startups, from smaller early-stage ventures to those seeking larger-scale funding for expansion.

4. Governance and Transparency Enhancements

Several measures focus on improving governance and ensuring transparency. Angel Funds will be required to disclose any proposed investments in related-party or group companies to their investors and seek explicit consent before proceeding. Additionally, allocations among investors must follow an objective and pre-disclosed methodology outlined in the Private Placement Memorandum (PPM).

5. Structural and Operational Changes

Proposals aim to refine operational processes, such as:

• Reducing the lock-in period for investments in startups to six months if the exit involves a sale to third parties.
• Mandating a continuing interest from fund managers or sponsors, requiring them to contribute at least 0.5% of the investment amount or ₹1 lakh, whichever is higher.
• Allowing employees and directors of the fund or its manager to invest in the Angel Fund, with a minimum threshold of ₹5 lakh.

6. Performance Reporting and Benchmarking

To improve accountability, SEBI proposes mandatory performance benchmarking for Angel Funds with investments exceeding ₹100 crore. This includes periodic reporting to investors and incorporating benchmark comparisons in the PPM and promotional materials. These measures are expected to provide investors with greater clarity on fund performance and ensure alignment with market standards.

7. Enhanced Investment Avenues

While Angel Funds are primarily focused on investing in startups as defined by DPIIT, the proposals allow up to 25% of investable funds to be allocated to other entities, such as unlisted companies, VCUs, or other Angel Funds. However, follow-on investments in portfolio companies that have graduated from the “startup” category will be restricted to existing investors, ensuring continuity without diluting regulatory intent.

8. Streamlined Compliance and Simplified Processes

SEBI recommends removing redundant requirements, such as filing term sheets with the regulator, and instead relying on periodic reporting. A template PPM for Angel Funds will be introduced to simplify disclosures, and the onboarding of Accredited Investors must be completed within 12 months of SEBI approval to ensure timely fund launches.

9. Transition Period for Existing Funds

Existing Angel Funds will be granted a one-year transition period to comply with the revised framework. During this time, funds with non-accredited Investors will be restricted to offering investment opportunities to no more than 200 investors. New regulations will apply to all Angel Funds established after the notification date.

Implications for the Startup Ecosystem

The proposed regulatory framework for Angel Funds in India has the potential to reshape the startup ecosystem. By limiting participation to Accredited Investors, the framework seeks to bolster investor protection and attract more institutional capital, potentially unlocking greater funding opportunities for early-stage startups. However, this restriction could also narrow the investor base, particularly for smaller Angel Funds that rely on a broader pool of contributors.

Adjustments to investment limits and diversification rules aim to balance risk and reward, providing fund managers with greater flexibility while safeguarding against excessive risk-taking. Introducing performance benchmarking further enhances transparency and accountability, empowering investors to make well-informed decisions about their investments.

Streamlining processes, such as eliminating the term sheet filing requirement, can reduce regulatory overhead for Angel Funds, enabling fund managers to focus on identifying and nurturing promising ventures. Nonetheless, it remains critical to ensure that these simplifications do not undermine investor safeguards or compromise the integrity of the regulatory framework.

Final Words

The proposed regulatory framework for Angel Funds in India strives to strike a balance between safeguarding investors and promoting innovation and growth within the startup ecosystem. Key measures, including limiting participation to Accredited Investors, standardizing the PPM, and introducing performance benchmarking, are designed to boost transparency, accountability, and investor trust. While these reforms have the potential to strengthen the industry, it is essential to ensure they do not unintentionally hinder innovation or create undue challenges for Angel Funds and startups. A thoughtfully crafted regulatory approach can position India as a leading global destination for startups, attracting talent, investment, and groundbreaking ideas.

[1] https://www.sebi.gov.in/reports-and-statistics/reports/nov-2024/consultation-paper-on-review-of-regulatory-framework-for-angel-funds-in-aif-regulations_88449.html

King Stubb & Kasiva,
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