International Joint Ventures and Merger & Acquisitions

Setting up of an Alternative Investment Fund in India

September 07, 2020

An analysis of the various forms of AIFs in India, and how they are set up under the provisions of SEBI and the FDI into such AIFs.

An Alternative Investment Fund or an AIF is a fund which has been incorporated within India through a privately-pooled investment vehicle responsible for the collection of funds from sophisticated investors for the purpose of investing it in accordance with a defined investment policy beneficial to the investors. Such an AIF does not include funds covered under the SEBI (Mutual Funds) Regulations, 1996, or SEBI (Collective Investment Schemes) Regulations, 1999, or any other regulation of this Board for the regulation of its fund management activity. Furthermore, certain exemptions from registration have also been given under the AIF Regulations for any family trusts established for the welfare of relatives as provided for and defined under the Companies Act, 1956. Further, employee welfare trusts or gratuity trusts established for the benefit of employees and holding companies within the meaning of Section 4 of the Companies Act, 1956 etc. have also been granted the same exemptions.

Any applicant seeking the registration of an AIF can do so by applying within any of the following categories and sub-categories, whichever is more appropriate:

  • Category I AIF:
  • Category II AIF
  • Category III AIF
  1. Venture capital funds (Including Angel Funds)
  2. SME Funds o Social Venture Funds o Infrastructure funds
This process has been better explained below:

Registration of an Alternative Investment Fund (AIF)

Certain set of regulations have been referred to under the SEBI (Alternative Investment Funds) Regulations, 2012, which had been introduced with the main objective of regulation of the pooled investment funds in India, such as, real estate, private equity and hedge funds. Such regulations were introduced to bring all the unregistered funds within the ambit of the law and its protection.

The same set of regulations also cover AIFs and refers to them as a fund established in the form of a trust, company, limited liability partnership or a body corporate. The several different designations of AIFs registered under the SEBI are known as the following:

  • An investment vehicle that is privately pooled in order to maintain the collection of funds from investors in accordance with a defined investment policy primarily for the benefit of investors, whether Indian or foreign investors. Such an AIF has not been covered under the SEBI (Mutual Funds) Regulations 1996, SEBI (Collective Investment Schemes) Regulations 1999, or any other regulation of the Board for the regulation of its fund management activities whatsoever.
  • However, as mentioned above, the SEBI Registered AIFs are classified into the following three categories:

Category I

The funds covered under this category are primarily involved with investments into start-ups for which they receive ample amount of incentives from the SEBI, the Government or any other regulating agency made responsible for the same This category comprises of social venture funds, infrastructure funds, venture capital funds and SME funds within its ambit.

Category II

The funds covered under this category are those which have been permitted to invest in any combination anywhere but are not allowed to undertake any borrowings except for the purposes of their day-to-day operations. This also includes funds such as private equity funds and debt funds.

Category III

The funds covered within this category are those which undertake short-term investments and subsequently sell the same as hedge funds. The following shall be exempted and not considered as an Alternative Investment Fund for the purposes of safeguarding the SEBI regulations:

  • Family trusts established for the benefit of the relatives as has been defined under the Companies Act, 1956.
  • All ESOP Trusts established under the SEBI (Employee Stock Option Scheme and Employee Stock Purchase Scheme) Guidelines, 1999, or as permitted under Companies Act, 1956.
  • All employee welfare trusts or gratuity trusts established for the benefit of employees.
  • Every holding company defined within the meaning of Section 4 of the Companies Act, 1956.
  • All other special purpose vehicles which have not been established by fund managers, including securitization trusts regulated under a specific regulatory framework.
  • All funds managed through a securitization company or a reconstruction company which has been registered with the Reserve Bank of India under Section 3 of the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002;
  • All pool of funds which are directly regulated by any other regulator in India, authorized with the powers to do so.

Registration of an AIF with SEBI

1. Application in Form A

According to the SEBI (AIF) Regulations, 2012, for the registration of an AIF, every such applicant must first make an application with SEBI as per the regulations provided for the same under Form A. Along with this application they must also attach the cover letter and all other necessary documents as mentioned on the portal.

2. Application Evaluation by SEBI

Once SEBI receives the application, it is its duty to reply to the applicant within a stipulated time period of 21 working days. However, such a response from SEBI is wholly reliant on whether the application form has been fully submitted with all the requisite documents, otherwise such an application may be rejected or sent back for re-evaluation.

3. SEBI Compliances

In order to ensure a speedy registration procedure, the applicant is required to go through the SEBI (Alternative Investment Funds) Regulations, 2012 thoroughly. This way, the applicant can be sure of not missing out on any attachments while making the application for registering the AIF.

4. Cover Letter

The cover letter is the first-mentioned attachment and thus the most important aspect for any AIF registration application. The details which must be mentioned within such a cover letter are given below:

  • If the said AIF has been registered with SEBI as a Venture Capital Fund then provision of the required details for the same.
  • In case, prior to the application, if it had already subsumed undertaking the activities of an AIF then the provision of all required details for the same.
  • The application form for the registration as a new fund entirely.

5. The Authorization Letter

For instances where an authorized signatory is involved, there is a requirement for the submission of an authorization letter from the Directors/Trustees/Designated Partners of the Fund therein.

6. Payment of registration fee to SEBI

For the registration to be complete, an online application form must be filed according to the guidelines prescribed under the SEBI regulations. After this, the applicant must submit Form A, which needs to be properly filled, numbered, duly signed and stamped. Along with this, an application fee of INR 1,00,000/- by way of a bank draft in the favor of “The Securities and Exchange Board of India”, payable at Mumbai, India, must be attached.

7. Certificate of Registration

  • In order to grant the certificate of registration of such an AIF, SEBI is required to consider all the requirements specified within its regulations and guidelines. Once these regulations have been deemed as complied with, the application can be approved by the SEBI and information regarding such acceptance shall then be communicated with the applicant.
  • Once the approval of SEBI has been acquired, the applicant is required to pay through a bank draft in the favour of “The Securities and Exchange Board of India”, payable at Mumbai, India, the registration fee based on the following structure:

1)      for an applicant not registered with the SEBI as a Venture Capital Fund (VCF):

a)      INR 5,00,000 for Category I AIF
b)      INR 10,00,000 for Category II AIF
c)      INR 15,00,000 for Category III AIF

2) for an applicant not already registered with the SEBI as VCF, a re-registration fees of INR 1,00,000.

  • On receipt of the registration or the re-registration fees, the SEBI shall grant a certificate of registration to the applicant as an AIF.
  • After the conclusion of the registration of the AIF, it is necessary that it complies with the reporting requirements specified under the SEBI guidelines.
  • For any update, circular or guidelines issued by SEBI with respect to the AIF activity, the AIF must check the SEBI website at regular intervals.
  • If any material or important noteworthy changes occur within the details that have already been furnished with the SEBI, the AIF must intimate the SEBI authorities of the same within a reasonable amount of time.

8. Necessary Compliances

FDI within AIF’s in India

As of this year, 100% FDI is permitted under automatic route in all the categories of AIFs. This has been explained further.

  • As per the rules of the FEMA 2020 Regulations, in situations where the sponsor as well as the manager are “owned and controlled” by Indian resident citizens, the AIF does not need to follow FDI downstream investment norms.
  • Further the extent of foreign investment within the corpus of the AIF must not be taken as a factor in determining whether any downstream investment by such an AIF is deemed to be a foreign investment.
  • All downstream investments by an AIF which has been deemed to be a foreign investment are required to conform with the sectoral caps and conditions or any restrictions applicable to the company wherein such a downstream investment is made.
  • Furthermore, in order to stipulate a special condition, a Category III AIF with any foreign investment must make portfolio investments in only such securities or instruments wherein an FPI has been permitted to invest as per the FEMA 2020 regulations.

Various Legal Forms in Which an AIF can be Established

As per the SEBI (Alternative Investment Funds) Regulations, 2012 and guidelines within it, all AIFs can be established or incorporated in the form of a trust or a company or as a limited liability partnership or even a body corporate. However, almost every AIF that is registered with the SEBI is registered as a trust.

Constitution of an AIF

The constitution or the “corpus’’ of an AIF refers to the total amount of funds which has been committed to it by investors on any specific date through a written contract or any other similar document. Furthermore, the following limitations have also been prescribed regarding the total number of investors under any AIF regulation:

  • None of the schemes of an AIF (other than an angel fund) shall have more than a 1,000 investors (unless the AIF has been formed as a company and the provisions of the Companies Act apply to it).
  • Further, a scheme shall not have more than 49 angel investors in case of an angel fund.
  • It is important to note that an AIF can raise funds from the sophisticated investors only through private placement and cannot make any invitations to the public at large for any subscriptions.

Complaint Redressal Mechanism

  • SEBI is a well-structured system which has a web-based centralized grievance redressal system, known as the “SEBI Complaint Redress System (SCORES)”, wherein any investor can lodge his or her complaint against any AIF for violation of norms or other grievance suffered.
  • As far as any dispute resolution is concerned, it is necessarily required for the AIF or its manager or sponsor to lay down procedures for further resolution of disputes between the investors, the AIF, the manager or the sponsor. Such dispute resolution could be either via arbitration or any other means which are mutually arrived at between both the parties.

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