Alternative Investment Funds

SEBI (Alternative Investment Funds)

Regulations, 2012
AIF Regulations are applicable to all privately pooled investment
vehicles:
Exemption:
mutual funds,
collective investment schemes,
family trusts,
ESOP Trusts,
employee welfare trusts,
holding companies,
funds managed by securitization companies or asset
reconstruction companies,
other special purpose vehicles not established by fund managers
including securitization trusts or any such pool of funds which is
directly regulated by any other regulator in India
Categories of AIFs based on investment philosophy
(a) Venture Capital Funds: These funds will primarily invest
in unlisted securities of start ups, emerging or early
stage venture capital undertakings mainly involved in
new products, new services, technology or intellectual
property rights based activities or a new business model.
(b) Hedge Funds: Hedge Funds will employ diverse or
complex trading strategies and invests and trades in
securities having diverse risks or complex products,
including listed and unlisted derivatives.
(c) Private Equity (PE) Funds: PE funds will invest
primarily in equity or equity linked instruments or
partnership interests of investee companies.
(d) Infrastructure Funds: These funds will primarily invest in unlisted
securities or partnership interest or listed debt or securitized
debt instruments of investee companies or special purpose
vehicles engaged in or formed for, the purpose of operating or
holding infrastructure projects.
(e) Debt Funds: These funds will primarily make investments in debt
or debt securities of listed or unlisted investee companies.
(f) Small and medium enterprises (SME) Funds: These funds will
invest primarily in unlisted securities of investee companies
which are SMEs or securities of those SMEs which are listed or
proposed to be listed on a SME exchange or SME segment of an
exchange.
(g) Social Venture Funds: These funds will invest primarily in
securities or units of social ventures and which satisfy social
performance norms laid down by the fund and whose investors
may agree to receive restricted or muted returns.

Categories- for registration with SEBI
Category - I
Funds which invest in
start-up or early stage ventures social ventures
SMEs
Infrastructure
other sectors or
areas which the government or regulators consider as socially or
economically desirable and
shall include
Venture Capital Funds,
SME Funds,
Social Venture Funds and
Infrastructure Funds and
such other AIF as may be specified.
Such funds formed as a trust or a company will be construed as a
venture capital company or venture capital fund, as specified
under Section 10 (23FB) of the Income Tax Act, 1961.
Category - II
This is the residual category and is for those
funds which cannot be classified either as
Category I or III and which do not undertake
leverage or borrowing, other than to meet
day to day operational requirements and as
permitted under these regulations.
This category will include PE Funds or Debt
Funds for which no specific incentives or
concessions are given by the government or
any other regulators.
Category - III
Funds in this category would adopt diverse or
complex trading strategies and may employ
leverage (including through investment in
listed/ unlisted derivatives).
This category will include Hedge Funds or
funds which trade with a view to make short
term returns or such other funds which are
open-ended and for which no specific
incentives or concessions are given by the
government or any other regulators.
Registration Rules
AIFs shall seek registration in one of the
categories mentioned and
in case of Category I AIF, in one of the
subcategories thereof.
An AIF which has been granted registration
under a particular category cannot change its
category subsequent to registration,
except with the approval of SEBI.

PROCEDURE

FOR

REGISTRATION

apply
See
requirements
validity

Certificate of registration to be valid till the AIF is wound
up.

Board to consider all the requirements laid down in AIF
Regulations for the purpose of grant of certificate
Application in Form A
Accompanied by non-refundable application fee as
specified in Part A
In the manner as in Part B
Change in control
change in control within the meaning of Reg 2 (1) (e)
of
SEBI (SAST) Regulations, 2011
control includes the right to appoint majority of the
directors or to control the management or policy decisions
in any other case, change in the controlling interest or
change in legal form
controlling interest means an interest, whether direct or
indirect, to the extent of more than fifty percent of voting
rights or interest
Therefore, the Regulations are very stringent not to allow
controlling interest to be exercised unless 50% interest is
there
features
The fund may raise funds from any investor whether
Indian,
foreign or
non-resident Indians
by way of issue of units.
Rs. 20 crore
each investor- 1 Crore
minimum corpus

25 lakhs
Director/employee
/Manager of Fund
1000 investors No of Investors
Investors in AIF
Each scheme of AIF shall have minimum corpus of INR
200 million ;
Minimum investment ticket size from a single investor is
INR 10 million. However, for investors who are employees
or directors of AIF / Manager minimum ticket size would
be INR 2.50 million;
Investment into AIF would be only by way of private
placement by issue of information memorandum or
placement memorandum;
AIF can launch schemes subject to filing of placement
memorandum with SEBI 30 days prior to launch of the
scheme; and
No material alteration to the fund strategy can be made
unless consent of at least 2/3 of unit holders by value of
their investment is obtained.

Investee company












Therefore, an AIF can invest even in LLP


COMPANY
LLP
BODY CORPORATE
SPV
Minimum interest
sponsor/manager
minimum
interest-2.5
Rs. 10
crore
Rs. 5 crore
For category
III-5 %
Listing
not permitted to raise funds through the stock
exchange
Listing can be done up to Rs. 1
crore
after final close of the fund or the
scheme
Investment
Up to 25% of the investible funds in any one investee
company
close-ended funds with a minimum tenure of 3 years.
Extend up to up to 2 years

Category I & II
Up to 10% of the investible funds in any
one investee company
may be either close-ended or open-ended

Category III
QIB- under ICDR 2009
Status
AIF shall not invest in associates except with the approval of 75% of investors by
value of their investment in the Alternative Investment Fund. AIF shall not invest
in associates except with the approval of 75% of investors by value of their
investment in the Alternative Investment Fund.

P L AC E M E N T M E M O R A N D U M

[R EG U L AT I O N 11]

Funds to be raised by issue of Information Memorandum/ Placement
IM to contain information, the key being:
Material information about AIF and Manager
Background of key investment team of manager
Tenure of AIF or scheme
Targeted investors
Investment strategy
Risk management tools and parameters employed
Conflict of interest and procedures to identify and address them
Manner of winding up of the Alternative Investment Fund or the scheme
The points so covered in the AIF Regulations are only inclusive in nature. AIFs to
share other relevant information as required to help investors take an informed
decision.
The procedure contemplated here, is similar to that of public offering of equity shares.
AIFs may launch schemes subject to filing of PM.
PM to be filed with SEBI atleast 30 days before the
launch of the scheme along with the fees prescribed in
Second Schedule
Scheme Fees is Rs. 1 lakh
Payment of scheme fees not applicable for launch of first
scheme
Existing Funds
Existing VCFs will be permitted to continue and shall
be governed by the VCF Regulations till such fund or
scheme managed by the fund is wound up.
VCFs will not be permitted to raise any fresh funds
after notification of these regulations
Existing funds (falling within the definition of an AIF)
not registered with SEBI may continue to operate for
6 months from the date of commencement of the
AIF Regulations

INVESTMENT

CONDITIONS

FOR

16] CATEGORY 1

[REGULATION

Shall invest in VCU or SPV or LLPs or other units of AIFs
May invest in units of Category I AIFs of same sub-category
Shall not borrow funds or engage in any leverage except:
For meeting temporary funding requirements:
Not more than 30 days
Not more than 4 occasions in a year
Not more than 10% of corpus
Therefore, Category I can fund in another fund too
CATEGORY

I-SECTORAL

CAPS

[REGULATION

16]

shares or equity linked instruments
VCFS
Additional conditions for VCFs- same as VCF Regulations
two-thirds/66.67% of the corpus shall be invested in unlisted equity
Not more than 1/3
rd
of corpus in:
IPO of VCU
Debt or dent instrument in which investment already made by way of equity or
contribution towards partnership interests
Preferential allotment of equity shares of listed company- lock in period of 1 year
Equity shares of a listed financially weak company or sick industrial
company
SPV
CONTD.

SMEs
Invest atleast 75% of corpus in unlisted
securities or partnerships of VCUs or listed or
proposed to be listed SMEs
Such funds may enter into an agreement
with Merchant Banker to subscribe to
unsubscribed portion of issue
Such funds exempt from Regulations 3 and 3A of Securities and
Exchange Board of India (Prohibition of Insider Trading)
Regulations, 1992 in case of investment in companies listed on
SME exchange subject to conditions prescribed.
CONTD.

muted
their
Social Venture Funds

Atleast 75%
of corpus in
unlisted
securities or
partnership
interest of
social
ventures

May accept
grants,
subject to
limit
provided
above

May give
grants to
social
ventures,
subject to
disclosure
in IM

May accept
returns for
investors
Infra fund
CONTD.

Atleast
75% of
corpus in
partnership interest of venture
involved in operating, developing
may also
invest in
securities of investee companies
involved in operating, developing
CATEGORY

II-SECTORAL

CAPS

[REGULATION

17]

borrow funds,
any leverage
with Merchant Banker to
portion of issue
Exempt from Regulations 3
and 3A from Insider Trading
Regulations in case of
investment in companies
listed on SME exchange
subject to conditions
prescribed.

May engage in hedging,
subject to guidelines
specified by SEBI

May enter into an agreement
subscribe to unsubscribed
Shall not
or engage in
except-
For meeting
temporary
fund
requirements
For not more
than 30 days,
not more than
4 occasions in
a year, not
more than
10% of the
corpus

Invest primarily in unlisted
investee companies or in
units of other AIFs

May invest in Category I or II
AIFs
Barred from investing in
units of other FoFs
CATEGORY

III-SECTORAL

CAPS

[REGULATION

18]


May invest in securities of listed or unlisted investee companies or
derivatives or complex or structured products

May invest in units of Category I or II AIFs
Barred from investing in units of other FoFs

May engage in leverage or borrow subject to consent from the investors
in the fund and subject to a maximum limit, as specified by SEBI.
Such funds to make disclosures as specified

To be regulated through issuance of directions on operational
standards, conduct of business rules, prudential requirements,
restrictions on redemption and conflict of interest as may be specified
by SEBI.
VENTURE CAPITAL
Meaning
Venture capital means funds made available
for startup firms and small businesses with
exceptional growth potential.

Venture capital is money provided by
professionals who alongside management
invest in young, rapidly growing companies
that have the potential to develop into
significant economic contributors.

Venture Capitalists generally:

Finance new and rapidly growing companies

Purchase equity securities

Assist in the development of new products or
services

Add value to the company through active
participation.

The SEBI has defined Venture Capital Fund in
its Regulation 1996 as a fund established in
the form of a company or trust which raises
money through loans, donations, issue of
securities or units as the case may be and
makes or proposes to make investments in
accordance with the regulations.

Now Repealed by AIF Regulations 2012
Advantages
It injects long term equity finance which provides a solid capital
base for future growth.
The venture capitalist is a business partner, sharing both the risks
and rewards. Venture capitalists are rewarded by business success
and the capital gain.
The venture capitalist is able to provide practical advice and
assistance to the company based on past experience with other
companies which were in similar situations.
The venture capitalist also has a network of contacts in many areas
that can add value to the company.
The venture capitalist may be capable of providing additional
rounds of funding should it be required to finance growth.
Venture capitalists are experienced in the process of preparing a
company for an initial public offering (IPO) of its shares onto the
stock exchanges or overseas stock exchange such as NASDAQ.
They can also facilitate a trade sale.
Stages of financing
1. Seed Money:
Low level financing needed to prove a new idea.
2. Start-up:
Early stage firms that need funding for expenses
associated with marketing and product development.
3. First-Round:
Early sales and manufacturing funds.
4. Second-Round:
Working capital for early stage companies that are
selling product, but not yet turning a profit .

5. Third-Round:
Also called Mezzanine financing, this is
expansion money for a newly profitable
company
6. Fourth-Round:
Also called bridge financing, it is intended to
finance the "going public" process

The concept of venture capital was formally
introduced in India in 1987 by IDBI.

The government levied a 5 per cent cess on all
know-how import payments to create the
venture fund.

ICICI started VC activity in the same year

Later on ICICI floated a separate VC
company - TDICI

Venture capital funds in India
VCFs in India can be categorized into following
five groups:

1) Those promoted by the Central Government
controlled development finance institutions. For
example:
- ICICI Venture Funds Ltd.
- IFCI Venture Capital Funds Ltd (IVCF)
- SIDBI Venture Capital Ltd (SVCL)



2) Those promoted by State Government
controlled development finance institutions.
For example:
- Punjab Infotech Venture Fund
- Gujarat Venture Finance Ltd (GVFL)
- Kerala Venture Capital Fund Pvt Ltd.

3) Those promoted by public banks.
For example:
- Canbank Venture Capital Fund
- SBI Capital Market Ltd


4)Those promoted by private sector
companies.
For example:
- IL&FS Trust Company Ltd
- Infinity Venture India Fund

5)Those established as an overseas venture capital fund.
For example:
- Walden International Investment Group
- HSBC Private Equity
management Mauritius Ltd




Rules & regulations of VC in India



AS PER SEBI
AS PER INCOME TAX ACT,1961
As per provision of income-tax rules:
The Income Tax Act provides tax exemptions
to the VCFs under Section 10(23FA) subject
to compliance with Income Tax Rules.

Restrict the investment by VCFs only in the
equity of unlisted companies.

VCFs are required to hold investment for a
minimum period of 3 years.
Contd
The Income Tax Rule until now provided that
VCF shall invest only upto 40% of the paid-up
capital of VCU and also not beyond 20% of
the corpus of the VCF.

After amendment VCF shall invest only upto
25% of the corpus of the venture capital fund
in a single company.

There are sectoral restrictions under the
Income Tax Guidelines which provide that a
VCF can make investment only in specified
companies.
Indian Venture Capital and Private
Equity Association (IVCA)
It was established in 1993 and is based in Delhi,
the capital of India
It is a member based national organization that
- represents venture capital and private
equity firms
- promotes the industry within India and
throughout the world
- encourages investment in high growth
companies and
- supports entrepreneurial activity and
innovation.

IVCA members comprise venture capital firms,
institutional investors, banks, incubators, angel groups,
corporate advisors, accountants, lawyers, government
bodies, academic institutions and other service providers
to the venture capital and private equity industry.

Members represent most of the active venture capital
and private equity firms in India. These firms provide
capital for seed ventures, early stage companies and
later stage expansion.


Top cities attracting venture capital
investments
CITIES SECTORS
MUMBAI Software services, BPO, Media, Computer
graphics, Animations, Finance & Banking
BANGALORE All IP led companies, IT & ITES, Bio-
technology
DELHI Software services, ITES , Telecom
CHENNAI IT , Telecom
HYDERABAD IT & ITES, Pharmaceuticals
PUNE Bio-technology, IT , BPO
HEDGE FUND
Introduction
Alfred Winslow Jones-1940s.
absolute return strategy

They make extensive use of short-sellingselling
a security they do not own in the expectation
that its price will falland derivatives.

Most such funds are open-ended
Hedge funds are sometimes called as rich mans
mutual fund.
Strategies
There are four broad groups of hedge fund
strategies: arbitrage, event-driven, equity-
related and macro
The first two groups in many cases
attempt to achieve returns that are
uncorrelated with general market
movements, where managers try to
find price discrepancies between
related securities, using derivatives
and active trading based on computer
driven models and extensive research
The second two groups are impacted
by movements in the market, and
they require intelligent anticipation of
price changes in stocks, bonds, foreign
exchange and physical commodities

Hedge Fund Strategies Can be Grouped into Four Major Categories
Source: McKinsey Global Institute; Hedge Fund Research, Inc.; David Stowell
Subcategory Description
A
r
b
i
t
r
a
g
e
Fixed-income
based arbitrage
Exploits pricing inefficiencies in fixed-income markets, combining long/short
positions of various fixed income securities
Convertible
arbitrage
Purchases convertible bonds and hedges equity risk by selling short the
underlying common stock
Relative value
arbitrage
Exploits pricing inefficiencies across asset classes-e.g., pairs trading, dividend
arbitrage, yield curve trades
E
v
e
n
t

D
r
i
v
e
n
Distressed
securities
Invests in companies in a distressed situation (e.g. bankruptcies, restructuring),
and/or shorts companies expected to experience distress
Merger arbitrage Generates returns by going long on the target and shorting the stock of the
acquiring company
Activism Seeks to obtain representation in companies' board of directors in order to
shape company policy and strategic direction
E
q
u
i
t
y

B
a
s
e
d
Equity long/short Consists of a core holding of particular equity securities, hedged with short
sales of stocks to minimize overall market exposure
Equity non-hedge Commonly known as "stock picking"; invests long in particular equity securities
M
a
c
r
o
Global Macro Leveraged bets on anticipated price movements of stock markets, interest
rates, foreign exchange, and physical commodities
Emerging markets Invests a major share of portfolio in securities of companies or the sovereign
debt of developing or "emerging" countries; investments are primarily long
In India, hedge funds can register under
category III of AIFs with SEBI.
So far there are 15 such funds registered with
SEBI.
Hedging and leverage are two key tools used
by hedge fund managers to generate positive
absolute returns but as per SEBI upto a limit.