SEBI Revamps Venture Capital Landscape with Major Amendments to AIF Regulations

Posted On - 30 July, 2024 • By - Hariom Bajpai

The Securities and Exchange Board of India (“SEBI”) has ushered in a significant regulatory change with the issuance of amendments to the Securities and Exchange Board of India Alternative Investment Funds Regulations, 2012 (“SEBI AIF Regulations”)[1]. This update, announced on July 20, 2024, through notification number SEBI/LAD-NRO/GN/2024/194,[2] introduces a new category within the venture capital fund landscape: Migrated Venture Capital Funds (“MVC Funds”). These amendments are poised to reshape the regulatory framework and operational landscape for venture capital funds in India.

Introduction of Migrated Venture Capital Funds:

Migrated Venture Capital Funds, as delineated under Regulation 19V (1), are defined as those funds that were initially registered under the SEBI AIF Regulations. These funds have now transitioned to be registered under the new regulations as a sub-category of Venture Capital Fund under Category I – Alternative Investment Fund. This transition is in accordance with the detailed provisions set forth in Chapter III-D of the amended regulations.

Applicability of the New Regulations:

The new Chapter III-D, introduced through these amendments, exclusively governs MVC Funds and the schemes launched by these funds. Regulation 19W specifies that the following provisions of the broader SEBI AIF Regulations will not apply to MVC Funds:

  1. Clause (p) and (w) of sub-regulation (1) of regulation 2. (Definitions)
  2. Sub-regulation (5) of regulation 3. (Registration of Alternative Investment Funds)
  3. Regulation 4. (Eligibility Criteria)
  4. Sub-regulations (2), (4), and (5) of regulation 6. (Procedure for Grant of Certificate)
  5. Sub-regulation (2) of regulation 7. (Conditions of Certificate)
  6. Regulations 9 (Investment Strategy), 10 (Investment in Alternative Investment Fund), 11 (Placement Memorandum), 12 (Schemes), 13 (Tenure), 14 (Listing), 15 (General Investment Conditions), and 16 (Conditions for Category I Alternative Investment Funds)
  7. Sub-regulations (11), (11A), (15), (17), (18), and (19) of regulation 20. (General Obligations and Transparency)
  8. Sub-regulations (2), (3), (4), and (5) of regulation 23 (Valuation).
  9. Sub-regulation (2) of regulation 27 (Maintenance of Records).

Introduction of Parallel Provisions:

To ensure that MVC Funds operate under a robust and transparent framework, SEBI has introduced parallel provisions within Chapter III-D. These new rules are designed to replicate the intent and rigour of the regulations that are otherwise not applicable to MVC Funds, ensuring a seamless transition and consistent regulatory oversight.

Regulation 19X: Detailed Procedure for Granting the Certificate

  1. Application Submission: Entities seeking registration as a migrated venture capital fund are required to submit their applications to SEBI, following the specific guidelines laid out by the Board. This process ensures that all applications are standardized and that SEBI has all the necessary information to evaluate each applicant thoroughly.
  2. Issuance of Registration Certificate: SEBI will grant the certificate of registration as a Category I Alternative Investment Fund – Venture Capital Fund (Migrated Venture Capital Fund) only if it is convinced that the applicant complies with all the stipulated requirements of this chapter. This rigorous evaluation process underscores SEBI’s commitment to maintaining high standards in the venture capital sector.

Regulation 19Y: Comprehensive Eligibility Criteria

To qualify for the coveted certificate, the applicant must meet several critical eligibility conditions, which SEBI will meticulously assess:

  1. Pre-existing Registration: The applicant must possess a valid certificate of registration as a Venture Capital Fund under the SEBI (Venture Capital Funds) Regulations, 1996. This ensures that only well-established entities with a proven track record are considered.
  2. Fit and Proper Status: It is imperative that the applicant is deemed fit and proper by SEBI, reflecting their integrity, financial soundness, and compliance with regulatory norms.
  3. Submission of Required Information: The applicant must furnish all the necessary information as specified by SEBI from time to time. This requirement ensures transparency and facilitates a thorough review process.
  4. Clear Record of Investor Complaints: Applicants must have no pending investor complaints regarding the non-receipt of funds or securities for any of their schemes, whose assets are not liquidated in accordance with regulation 24(2) of the SEBI (Venture Capital Funds) Regulations, 1996, as of the application date. This criterion ensures that only entities with a clean track record are granted registration.
  5. Minimum Investment Threshold: Schemes launched by the applicant should not have investments from any single investor below INR 5 lakh, except for specific categories of investors, such as employees, directors, or trustees associated with the venture capital fund. This condition aims to ensure that funds are raised from credible sources, maintaining the integrity of the investment pool.
  6. Investor Commitment Requirement: Each scheme must secure a firm commitment from investors for contributions of at least INR 5 crore before initiating operations. This stipulation ensures that there is substantial investor confidence and commitment, thereby enhancing the stability and credibility of the fund.

Regulation 19Z: Strict Prohibition on Public Invitations

  1. Migrated venture capital funds are explicitly prohibited from issuing any documents or advertisements that invite the public to subscribe to or purchase units of the fund. This measure is designed to prevent undue solicitation and maintain the exclusivity and integrity of the venture capital investment process.
  2. These new regulations are a significant step forward, enhancing the transparency, accountability, and overall credibility of migrated venture capital funds in India. By setting clear standards and rigorous requirements, SEBI aims to foster a robust and trustworthy venture capital ecosystem, paving the way for sustained growth and innovation in the industry.

Section 19AA: Private Placement of Units

Migrated venture capital funds are permitted to raise investment monies exclusively through the private placement of their units. This method ensures that investments are targeted and managed within a select group of investors, providing a controlled and strategic approach to fundraising.

Section 19AB: Placement Memorandum or Subscription Agreement

  1. Issuance Requirements: The migrated venture capital fund must either:
    1. Issue a Placement Memorandum: This document should comprehensively detail the terms and conditions under which monies are proposed to be raised from investors. It serves as a key communication tool, offering potential investors all necessary information to make informed decisions.
    2. Enter into a Contribution or Subscription Agreement: This legally binding document with investors should explicitly specify the terms and conditions for raising investment monies, ensuring transparency and mutual understanding between the fund and its investors.
  2. Regulatory Filing: The fund is required to file with the regulatory Board a copy of the placement memorandum or the subscription agreement. Additionally, a report detailing the actual monies collected from investors must be submitted. This filing ensures regulatory compliance and provides a record for oversight and transparency.

Section 19AC: Contents of Placement Memorandum

The placement memorandum or the subscription agreement must encompass a broad array of critical information to provide clarity and transparency to investors. The required contents include:

  1. Trustee and Management Information: Detailed information about the trustees or trustee company, and the directors or chief executives of the migrated venture capital fund. This includes their backgrounds, qualifications, and roles within the fund, offering investors insight into the fund’s leadership.
  2. Fund Corpus and Minimum Investment Details: Information on the total corpus of the fund, the minimum amount required for the fund to be operational, and the minimum amount required for each investment scheme. Provisions for refunding monies to investors if these minimum amounts are not met should also be clearly outlined.
  3. Investor Entitlements: Detailed descriptions of the entitlements on the units of the venture capital fund for which subscription is being sought, helping investors understand their rights and benefits.
  4. Tax Implications: A thorough explanation of the tax implications that are likely to apply to investors, enabling them to assess the financial impact of their investments.
  5. Subscription Process: Clear instructions on how investors can subscribe to the units of the migrated venture capital fund, including any necessary forms or procedures.
  6. Fund Maturity Period: Information on the period of maturity, if any, of the fund, giving investors a timeline for their investment horizon.
  7. Winding Up Procedures: Detailed procedures for how the fund shall be wound up, if applicable, ensuring investors understand the exit strategy and final distribution of assets.
  8. Distribution of Benefits: The method by which benefits accruing to investors in the units of the trust are to be distributed, ensuring transparency in the fund’s benefit-sharing mechanism.
  9. Fund Management Details: Information about the fund manager or asset management company, including their experience, track record, and the fees to be paid. This helps investors evaluate the competency and cost of the fund management.
  10. Fund Performance History: Details about the performance of the fund, if any, managed by the Fund Manager. Historical performance data can provide investors with insights into the potential returns and risks.
  11. Investment Strategy: A comprehensive outline of the fund’s investment strategy, including target sectors, geographical focus, and risk management approaches. This helps investors align their own investment goals with those of the fund.

Regulation 19AD: Investment Limits

  1. Diversification Requirement: To promote diversification and reduce risk, a migrated venture capital fund is restricted from investing more than 25% of its total corpus in any single venture capital undertaking. This measure ensures that the fund’s resources are spread across multiple ventures, minimizing exposure to the potential failure of any single investment.
  2. International Investment Opportunities: Migrated venture capital funds are permitted to invest in companies incorporated outside India. However, these investments are subject to specific conditions or guidelines issued by the Reserve Bank of India (RBI) and SEBI. This provision opens up opportunities for global investment while ensuring regulatory oversight and compliance.
  3. Avoiding Conflicts of Interest: To maintain impartiality and prevent conflicts of interest, migrated venture capital funds are prohibited from investing in associated companies. This restriction helps ensure that the funds are invested in independent ventures, thereby safeguarding the interests of the fund’s stakeholders.
  4. Primary Investment Mandate: At least 66.67% of the investable funds must be allocated to unlisted equity shares or equity-linked instruments of venture capital undertakings. This focus on unlisted entities encourages support for early-stage companies and startups, fostering innovation and entrepreneurship.
  5. Secondary Investment Options: Up to 33.33% of the investable funds can be allocated to other investment avenues, including:
  6. Initial Public Offer (IPO): Subscription to the IPO of a venture capital undertaking, providing an exit opportunity for early investors.
    1. Debt Instruments: Investment in the debt or debt instruments of a venture capital undertaking where the fund has already made an equity investment. This allows for structured financing options within the same company.
    2. Preferential Allotment: Participation in the preferential allotment of equity shares of a listed company, provided there is a lock-in period of one year, ensuring a longer-term commitment.
    3. Financially Weak Companies: Investment in the equity shares or equity-linked instruments of financially weak companies or sick industrial companies whose shares are listed. This supports the turnaround of distressed businesses.
    4. Explanation: A “financially weak company” is defined as a company that, at the end of the previous financial year, has accumulated losses eroding more than 50% but less than 100% of its net worth at the beginning of the previous financial year.
    5. Special Purpose Vehicles (SPVs): Investments can also be made in SPVs created specifically to facilitate or promote investments in accordance with these regulations. This provides a structured mechanism for targeted investments.
  7. Lifecycle Compliance: The stipulated investment conditions and restrictions must be met by the end of the venture capital fund’s lifecycle. This ensures a long-term adherence to the regulatory framework and strategic investment planning.
  8. Support for Public Issues: Migrated venture capital funds may enter into agreements with merchant bankers to subscribe to unsubscribed portions of an issue or engage in market-making activities. During such activities, the standard investment conditions do not apply, allowing flexibility in acquiring or selling securities.
  9. Regulatory Oversight: SEBI reserves the right to specify additional requirements or criteria for investments by migrated venture capital funds. This provision ensures that the regulatory framework can adapt to evolving market conditions and emerging risks.

Regulation 19AE: Scheme Restrictions

No New Schemes: Migrated venture capital funds are prohibited from launching new schemes. This restriction ensures that the funds remain focused on managing and maximizing returns from their existing portfolios.

Regulation 19AF: Tenure of Migrated Venture Capital Funds

  1. Tenure Calculation: The tenure for a migrated venture capital fund will be determined based on criteria specified by the Board. This ensures a standardized approach to calculating the duration of these funds.
  2. Extension of Tenure: An extension of up to two additional years may be granted, provided that two-thirds of the unit holders, based on the value of their investments in the migrated venture capital fund, approve the extension. This mechanism allows for flexibility in managing the fund’s lifecycle, subject to substantial stakeholder consent.
  3. Winding Up: If the extension is not approved by the unit holders or if the extended tenure expires, the migrated venture capital fund or its scheme must be wound up in accordance with Regulation 29. It is important to note that sub-regulation (9A) of Regulation 29 does not apply to migrated venture capital funds, providing specific conditions for their winding-up process.
  4. Additional Liquidation Period: Should a scheme from a venture capital fund previously registered under the Securities and Exchange Board of India (Venture Capital Regulations), 1996, remain illiquid after its initial tenure, and the fund has been registered as a migrated venture capital fund under the new regulations, the Board may grant an additional period for liquidation. This additional period will be subject to conditions outlined by the Board. The registration as a migrated venture capital fund and any additional liquidation period granted are without prejudice to any directives or measures issued under the applicable Act and regulations.

Regulation 19AG: Listing Restrictions

Migrated venture capital funds are prohibited from listing their units on any recognized stock exchange for a period of three years from the date of issuance of those units. This restriction aims to maintain stability and compliance during the initial period following migration.

Regulation 19AH: Record Maintenance

Migrated venture capital funds are required to maintain their records for a period of eight years following the winding up of the fund. This extended record-keeping obligation ensures transparency and accountability even after the fund’s operational phase has concluded.

[1] https://www.sebi.gov.in/legal/regulations/jul-2024/securities-and-exchange-board-of-india-alternative-investment-funds-regulations-2012-last-amended-on-july-20-2024-_84955.html

[2] https://www.sebi.gov.in/legal/regulations/jul-2024/securities-and-exchange-board-of-india-alternative-investment-funds-third-amendment-regulations-2024_84929.html