Missing Ingredients in SEBI and IFSCA Co-Investment Regulations

Regulation 2(1)(fa) of the SEBI (Alternative Investment Funds) Regulations, 2012 (“AIF Regulations”) defines co-investment as follows:

“Co-investment” means investment made by a Manager or Sponsor or investor of a Category I or II Alternative Investment Fund in unlisted securities of investee companies where such a Category I or Category II Alternative Investment Fund makes investment.”

Essentially this means that if the investor of an AIF (“Investor”) invests in a portfolio company of the AIF (“Portfolio Company”) for any reason whatsoever, it amounts to a “co-investment”. An investor of an AIF may invest in a Portfolio Company due to the following reasons:

• The investment manager (“IM”) or sponsor (“Sponsor”) of the AIF facilitated or arranged the investment by the Investor in the Portfolio Company. The IM or Sponsor may even have solicited such investment by the Investor in the Portfolio Company. The IM or Sponsor may have shared with the Investor the legal and financial due diligence reports on the Portfolio Company prepared by the AIF’s advisors prior to the AIF’s investment. Templates of the agreements entered into by the AIF and the Portfolio Company and/or the promoters of the Portfolio Company may also have been shared to reduce the Investor’s costs in connection with the Investor’s investment in the Portfolio Company. The Investor may or may not have paid a fee to the IM or Sponsor for facilitating the Investor’s investment in the portfolio company.
• The Investor invested in the Portfolio Company independent of the IM or Sponsor. The IM or Sponsor may not even have been aware of the Investor’s investment in the Portfolio Company until the investment actually took place.

All the scenarios outlined above will fall within the ambit of “co-investment” as defined in Regulation 2(1)(fa) of the AIF Regulations.

Regulation 17A (1) of the AIF Regulations states that co-investment by investors of Category I or Category II AIFs shall be through a co-investment scheme launched under these regulations or through a Co-investment Portfolio Manager. The word “only” has not been used in this Regulation, but SEBI’s intent is very clear. If co-investment by investors of Category I or Category II AIFs takes place directly, that is, other than through a CIV Scheme or through a Co-investment Portfolio Manager, it is likely to be treated as a breach of the aforementioned Regulation 17A.

IFSCA’s regulations for co-investments are contained in Regulations 29 and 41 of the International Financial Services Centres Authority (Fund Management) Regulations, 2025 (“FM Regulations”) and these state as follows:

“A [venture capital/restricted] scheme may co-invest in permissible investments under sub-regulation (1) of regulation [22/34] either through a special purpose vehicle (SPV) in accordance with the framework specified by the Authority or through a segregated portfolio by issuing a separate class of units.”

Pursuant to Regulations 29 and 41 of the FM Regulations, IFSCA issued a circular dated May 21, 2025, which allows a VCS or a Restricted Scheme in an IFSC to launch a Special Scheme to facilitate co-investment. The Fund which launches the Special Scheme is required to hold at all times a minimum of at least 25% of the equity share capital, interest, or capital contribution in the Special Scheme.

Just as in the case of SEBI, IFSCA Regulations do not expressly state that “co-investments” can take place only through a Special Scheme or a segregated portfolio created by the AIF, but IFSCA’s intent is clear enough. If co-investment by

investors of an AIF in an IFSC takes place directly, that is, other than through a Special Scheme or through a segregated portfolio created by the AIF, it is likely to be treated as a breach of IFSCA’s Regulations.

Once again, we are forced to ask, what if the investor of a VCS or a Restricted Scheme set up in an IFSC invests in a portfolio company of the VCS or Restricted Scheme on its own, without paying any fee to the VCS or Restricted Scheme or to the IM of the main scheme for facilitating the co-investment? Would the VCS or Restricted Scheme or the IM of the relevant scheme be deemed to have violated IFSCA’s regulations?

It should be borne in mind that, just because an AIF has invested in an unlisted company, the AIF does not necessarily control its cap table or future fundraising. It is submitted that the definition of “Co-investment” should include either or both of the following ingredients:

• Payment of consideration by the co-investor to the IM or to the AIF;
• Facilitation or solicitation of the co-investment by the IM.

It is submitted that an IM of an AIF should be entitled to facilitate the direct investment by one of the investors in the AIF into a portfolio company of the AIF without having to create a CIV Scheme or obtaining a Co-Investment PMS License, as long as the IM does not receive any fee or other consideration from such investor. Even if the IM facilitated such investment, as long as the IM did not receive any fee or other consideration from such investor, the IM should not be construed to have violated SEBI’s or IFSCA’s co-investment regulations.

Let’s compare SEBI’s regime for co-investments with a similar regulation, namely the Securities and Exchange Board of India (Investment Advisers) Regulations, 2013 (“IA Regulations”). Under the IA Regulations, an “investment adviser” is defined to mean any person, who for consideration, is engaged in the business of providing investment advice to clients or other persons or group of persons and includes any person who holds out himself as an investment adviser, by whatever name called. In other words, a person who dispenses investment advice free of charge is not bound to register with SEBI under the IA Regulations or comply with it in any manner.

Under SEBI’s CIV Scheme regime, only accredited investors can invest via a CIV Scheme. If the investor of a Category I AIF or a Category II AIF, who is not an accredited investor, directly invests in a portfolio company of the AIF on his/her/its own and without paying any fee to the AIF or to the IM, would the AIF or the IM be held to have violated SEBI’s regulations? Would a portfolio company of an AIF which accepts an investment from an investor who has also invested in such company via the AIF, be deemed to have permitted the circumvention of SEBI’s regulations?

Category III AIFs registered with SEBI are not covered by SEBI’s CIV Scheme regime for an understandable reason, which is that Category III AIFs usually invest in listed securities. However, Category III AIFs are also permitted to invest in unlisted securities, though they usually do not. If the investor in a Category III AIF which has invested in unlisted securities directly invests in an unlisted portfolio company of the AIF on his/her/its own and without paying any fee to the AIF or to the IM, would the Category III AIF or the IM be held to have violated SEBI’s regulations?

One of the objectives of SEBI and IFSCA in regulating co-investments is to ensure that co-investors do not get better terms than the AIF itself. If the facilitation of co-investment without receiving any consideration is exempt from registration or regulation, the IM of an AIF could misuse the co-investment route to get better terms for the co-investors from a portfolio company than was offered for the AIF itself. However, if the IM is not receiving any consideration from the co-investor, why would an IM go out of its way to get better terms for a co-investor to the detriment of the AIF managed by itself?

Also, it is a commercially well accepted fact that investors who invest at different periods in time get different valuations and other commercial terms. The portfolio company of an AIF which is not performing well may offer better terms to an investor who invests one year after the AIF has invested in it.

It is hoped that answers to these questions will be provided by the regulator soon and the gaps in regulations are plugged in the near future.