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 thedirectors 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 lakhsDirector/employee /Manager of Fund

•1000 investorsNo 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. 10crore

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 2009Status

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 1/3rd 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 industrialcompany

• SPV

CONTD….

SMEsInvest 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 fundCONTD….

Atleast75% ofcorpus

in

partnership interest of venture

• involved in operating, developing

may alsoinvest 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 than4 occasions in a year, not more than10% of the corpus

Invest primarily in unlisted investee companies or in

units of other AIFs

May invest in Category I or IIAIFs

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

MeaningVenture 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 sectorcompanies.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 SEBIAS 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-selling—selling a security they do not own in the expectation that its price will fall—and derivatives.

• Most such funds are open-ended • Hedge funds are sometimes called as ‘rich man’s 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 DescriptionAr

bitr

age

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

Even

t Dr

iven

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

Equi

ty

Base

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

Mac

ro

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.