Venture Capital Fund
Venture Capital is the initial capital provided to a business typically at a start-up stage. Venture capital normally comes in where the conventional sources of finance do not fit in such as bank loans or capital from public market. Majority of venture capital investors are either, a group of High Networth Individuals (HNIs), investment banks or other financial institutions. They pool in investments or form a partnership to raise capital.
A venture capital fund is a pooled investment scheme that primarily invests the capital of third-party investors in an enterprise. The fund makes money by owning equity in the companies it invests in, generally with strong growth potential. A venture capital fund is characterized as high-risk/high-return opportunity but most times, the fund structure diversifies risks. The Venture Capital Fund investors use their business knowledge, experience and expertise to yield substantial return on the investment.
Every venture capital fund shall issue a placement memorandum to its proposed investors or enter into a subscription agreement with its proposed investors. It shall specify the terms and conditions subject to which monies are proposed to be raised.
The placement memorandum or the subscription agreement shall contain:
- details of the trustees or trustee company (and the directors or chief executives) of the venture capital fund;
- the proposed corpus of the fund and the minimum amount to be raised for the fund to be operational;
- the minimum amount to be raised for each scheme and the provision for refund of monies to investor in the event of non-receipt of minimum amount;
- details of entitlements on the units of venture capital fund for which subscription is being sought;
- tax implications that are likely to apply to investors;
- manner of subscription to the units of the venture capital fund;
- the period of maturity, if any, of the fund;
- the manner, if any, in which the fund shall be wound up;
- the manner in which the benefits accruing to investors in the units of the trust are to be distributed;
- details of the fund manager or asset management company if any, and the fees to be paid to such manager;
- the details about performance of the fund, if any, managed by the Fund Manager;
- investment strategy of the fund;
- any other information specified by the Board.
The Venture Capital Funds (VCF) Regulation 1996 issued by Securities and Exchange Board of India (SEBI), is a comprehensive set of laws to be followed by any venture capital fund in India. From the registration of venture capital funds to the action to be taken in case of default, the regulation has been divided in VI chapters.
Regulation 2(m) of the VCF Regulation defines a venture capital fund as follows: “venture capital fund” means a fund established in the form of a trust or a company including a corporate body and registered under these regulation which—
- has a dedicated pool of capital;
- raised in a manner specified in the regulations; and
- invests in accordance with the regulations
The VCF Regulation 1996 provided for the registration of a company or a trust which either was functioning as a venture capital fund before the commencement of this act or proposes to do so after the commencement of this act. A venture capital fund can either be a fund established as a trust under the Indian Trust Act, 1882 or a company under Companies Act, 1956. The eligibility criteria for grant of a certificate of registration are given in Regulation 4 of SEBI (Venture Capital Funds) Regulations 1996.
However, SEBI on May 21, 2012 notified the SEBI (Alternate Investment Fund) Regulations, 2012 (“AIF Regulations”) aiming at a complete overhaul of the regulatory regime governing private pooled investment vehicles in India and in the process replacing the VCF Regulations 1996.
All AIFs whether operating as Private Equity Funds, Real Estate Funds, Hedge Funds, etc. must register with SEBI under the AIF Regulations. However, existing VCFs shall continue to be regulated by the VCF Regulations till the existing fund or scheme managed by the fund is wound up. Such VCFs may also seek reregistration under AIF regulations subject to approval of 66.67% of their investors by value.
Until now, the regulatory environment governing management of private pool of funds, albeit at a retail level, was restricted to Mutual Funds (MF), Collective Investment Schemes (CIS), Venture Capital Funds (VCF) etc. Hence, there was a need felt to address and focus on the non-retail segment. Moreover, the cardinal reason behind the Securities and Exchange Board of India (“SEBI”) coming up with the SEBI (Venture Capital Funds) Regulations, 1996 (“VCF Regulations”) was to provide impetus and encourage various start up enterprises, by providing the necessary seed fund. However, over the years, VCFs have come to be used as vehicles for funds such as PE, real estate, infrastructure etc. There is no doubting of the objectives of such funds but what happened in the process is that the objective and the principal reason in enactment of the VCF Regulations got diluted.
Thus, acknowledging the dynamic nature of the market and the ever evolving landscape of the capital market of a developing economy, there was a need of much required revision to the old rules, so that they do not prove to be bottleneck in the progress and development of the economy.
The AIF Regulations are a broad-based legislation governing various kinds of private funds and permitting more investment opportunities for investment managers. The VCF Regulations restricted some of the accepted investment avenues worldwide—like secondary transactions in listed stock, derivative transactions, debt funds and investing using a fund of funds model. SEBI seems to have permitted such investments and has created a regulatory structure governing such investments under the AIF Regulations.
AIF means any fund established or incorporated in India in the form of a trust or a company or a limited liability partnership or a body corporate which is a privately pooled investment vehicle which collects funds from investors, whether Indian or foreign, for investing it in accordance with a defined investment policy for the benefit of its investors. Thus typically, after the enactment of the AIF Regulations, the following are the investment vehicles:
- Mutual Funds (MF)
- Collective Investment Schemes (CIS) and
- Alternative Investment Fund (AIF)
An application can be made to SEBI for registration as an AIF under one of the following categories:
- Category I AIF – those AIFs with positive spillover effects on the economy, for which certain incentives or concessions might be considered by SEBI or Government of India or other regulators in India; and which shall include Venture Capital Funds, SME Funds, Social Venture Funds and Infrastructure Funds.
- Category II AIF – those AIFs for which no specific incentives or concessions are given by the government or any other Regulator; which shall not undertake leverage other than to meet day-to-day operational requirements as permitted in these Regulations; and which shall include Private Equity Funds, Debt Funds, Fund of Funds and such other funds that are not classified as category I or III.
- Category III AIF – those AIFs which include hedge funds that are considered to have negative externalities such as exacerbating systemic risk through leverage or complex trading strategies. These funds can be open ended or close ended, may engage in leverage subject to limits as may be specified by the Board.
A VCF under AIF Regulations attracts certain restrictions, which include investment restrictions (investment of at least 66% of the corpus in equity or equity linked instruments). AIF may raise funds from any investor whether Indian, foreign or non-resident Indians by way of issue of units.
- Each scheme of the AIF shall have corpus of at least Rs.20 crore.
- AIF shall not accept from an investor, an investment of value less than Rs.1 crore.
- No scheme of the AIF shall have more than 1000 investors.
- AIF shall not invest in associates except with approval of 75% of investors.
- The AIF shall not solicit or collect funds except by way of private placement.
All AIFs shall have QIB status as per SEBI (Issue of Capital and Disclosure Requirement), 2009 (“ICDR Regulations”).
- Category I and II AIFs shall be close-ended and shall have a minimum tenure of 3 years. However, Category III AIF may either be close-ended or open-ended.
- Units of AIF may be listed on stock exchange subject to a minimum tradable lot of Rs.1 crore. However, AIF shall not raise funds through Stock Exchange mechanism.
- Category I and II AIFs shall not be permitted to invest more than 25% of the investible funds in one Investee Company. Category III AIFs shall invest not more than 10% of the corpus in one Investee Company.
- The Manager or Sponsor shall have a continuing interest in the AIF (For Category I and II) of not less than two and half percent of the corpus or Rs.5 crore, whichever is lower and (For Category III) of not less than five percent of the corpus or Rs.10 crore, whichever is lower, respectively.
- The Manager or Sponsor shall disclose their investment in the Alternative Investment Fund to the investors of the AIF.
- The removal of the erstwhile requirement in the draft AIF Regulations for the Manager to buy out the investments at the time of winding down the AIF is a welcome move. The key investment team of the Manager should also have adequate experience, with at least one key personnel having not less than 5 years of fund management experience, along with relevant professional qualifications.
- Till now, the Manager was not saddled with any mandatory reporting responsibilities to the Investors. The Manager will now have to make detailed reports to its Investors specifically with respect to financial, risk management, operation, portfolio and transactional information regarding fund investments.
- Valuation of investments will be required to be done at least once every six months, and a description of the valuation and methodology adopted, will need to be provided to the Investors.
- Requirement to set up a dispute resolution procedure through arbitration or any other mechanism can be termed as a breath of fresh air.
- A custodian will be required to be appointed if the fund corpus exceeds Rs.500 crores.
All AIFs whether operating as Private Equity Funds, Real Estate Funds, Hedge Funds, etc. must register with SEBI under the AIF Regulations.
However, existing VCFs registered under VCF Regulations 1996 shall continue to be regulated by the VCF Regulations till the existing fund or scheme managed by the fund is wound up. Existing VCFs, however, shall not increase the targeted corpus of the fund or scheme as it stands on the day of Notification of these Regulations. Such VCFs may also seek re-registration under AIF regulations subject to approval of 66.67% of their investors by value.
Existing funds not registered under the VCF Regulations will not be allowed to float any new scheme without registration under AIF Regulations. However, schemes floated by such funds before coming into force of AIF Regulations, shall be allowed to continue to be governed till maturity by the contractual terms, except that no rollover/ extension or raising of any fresh funds shall be allowed.
ArthVeda Star Fund is the existing scheme of the SEBI registered venture capital Fund/ Trust and will be governed under SEBI Venture Capital Fund Regulation, 1996 and under all other relevant Indian Laws till its target corpus is achieved. However, the future schemes of the Fund will be set up and operate in accordance with the Indian laws, including but not limited to the SEBI (Alternative Investment Funds) Regulations, 2012, the regulations and provisions of SEBI, FDI, FEMA and tax laws. Investors should seek independent advice in this regard.