Angel funds are regulated by Chapter III A of the SEBI (Alternative Investment Funds) Regulations, 2012 (AIF Regulations). Chapter III-A was inserted in the AIF Regulations with effect from September 16, 2013. Angel funds are rather unique and different from other AIFs in many ways. Angel funds must raise capital from eligible “angel investors” and invest in start-ups as defined by the Department for Promotion of Industry and Internal Trade, Ministry of Commerce and Industry, Government of India. Before making any investment, the manager of an angel fund is required to obtain approval from investors on a deal-by-deal basis. Due to these unique features of angel funds, certain rules (such as the mandatory use of a prescribed PPM template, yearly audit of compliance with the PPM by the AIF, and reporting to performance benchmarking agencies, etc.) are not applicable to angel funds. There are also many variations among angel funds in their operational practices, relating to commitment periods, closing procedures, and the offering of investment opportunities, due to a lack of explicit clarity in the current regulatory framework. This resulted in frequent requests from industry stakeholders for clarifications and informal guidance.
In response, the Securities and Exchange Board of India (SEBI) established a working group in July 2022, consisting mainly of angel fund managers and other stakeholders, to carry out a comprehensive review of the regulatory framework for angel funds and provide recommendations on this matter. Pursuant to such review, on November 13, 2024, SEBI issued a consultation paper (Consultation Paper) to solicit views from the public on various proposals that would amend and streamline the provisions of the AIF Regulations relating to angel funds. SEBI’s proposals aim to, inter-alia, ensure that only investors with commensurate risk appetite and ability invest in angel funds, while also enhancing the ease of doing business in this space.
- There exist two types of angel fund structures within the AIF Industry, namely a) funds which structurally resemble a close-ended VCF and have a defined corpus, fund life etc.; and b) funds formed by angel networks that do not have a defined life or corpus size most of the time. Investors join when they feel the need to invest and leave the network when they do not wish to be part of network any longer. The Government in its Budget Announcement for FY 2024 – 25, abolished “angel tax” for all classes of investors, in order to bolster the Indian start-up eco-system and support innovation. Due to the removal of angel tax, there is less incentive for angel investors to set up angel funds to invest in start-ups and a greater incentive to invest directly. Hence SEBI has raised a fundamental question whether it makes sense to regulate under the AIF Regulations the investments made by “angel investor pools” through angel funds.
- An angel fund framework provides angel investors an opportunity to avail expertise of experienced, professional fund managers in accessing and managing investments in start-ups along with discretion to invest in start-ups of their liking. Further, the investment is made and managed in the name of the angel fund which offers ease of operation for start-ups and angel investors and bolsters the start-up ecosystem in the country. Therefore, SEBI’s Alternative Investment Policy Advisory Committee (“AIPAC”) has recommended that angel funds be maintained as a regulated structure. AIPAC members have also highlighted that besides AIFs, there may not be any other legitimate avenues for pooling funds to invest in start-ups.
- Since AIPAC has recommended that SEBI should continue to regulate angel funds under its AIF Regulations, a number of additional proposals have also been put forth, of which the following are key:
- Only accredited investors may invest in angel funds. Even if only accredited investors are allowed to invest, the 200- investor limit per company of angel fund shall remain, but will exclude Qualified Institutional Buyers (QIBs) as defined under SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018.
- The AIF Regulations provide a lower investment threshold[1] for investors who are employees or directors of the AIF or employees or directors of the AIF’s investment manager. Such a lower limit has not been provided for in the case of angel funds. The Consultation Paper proposes that the minimum investment threshold for employees and directors of angel funds and its investment manager be set at INR 5 lakh.
- Regulation 19(D)(3) of the AIF Regulations states as follows: “Angel funds shall accept, up to a maximum period of five years, an investment of not less than twenty-five lakh rupees from an angel investor.” The Consultation Paper has mooted the deletion of the aforementioned Regulation 19(D)(3), since it has been proposed that only accredited investors can invest in angel funds.
- To replace the requirement of a minimum corpus of INR 5 Crore for angel funds with requirement that Angel Fund shall start investing only after on boarding a minimum of five accredited investors. Since the concept of “corpus” shall become irrelevant, the continuing interest of sponsors/managers shall be linked to the total investments made by the angel fund, rather than its corpus.
- Currently the Regulation 19F(2) of the AIF Regulations provides that an investment by an angel fund in any venture capital undertaking shall not be less than INR 25 Lakhs and shall not exceed INR 10 Crore. These limits shall be modified and it is proposed that investment by an Angel Fund in any start-up shall not be less than INR 10 Lakhs and shall not exceed INR 25 Crore.
- Reg 19F(5) of AIF Regulations currently mandates that no more than 25% of the total investments under all schemes of an Angel Fund can be made in a single venture capital undertaking, provided that the compliance to this regulation shall be ensured by the angel fund at the end of its tenure. However, adhering to this requirement at the end of the fund’s tenure has been found to be neither feasible for angel funds nor easily verifiable by the regulator. Further, meeting the diversification requirement only at the end of the fund’s life cycle does not adequately mitigate investment concentration risks. Therefore, it is proposed that the 25% diversification limit specified in Regulation 19F(5) of the AIF Regulations be removed.
- Currently, it is possible that an AIF’s investment in an investee company will be supported by a single investor, since investors have the right to opt out. In order to prevent angel funds from becoming vehicles for single-investor or single-investment structures, it is proposed that each investment made by an angel fund must involve contributions from at least three investors (excluding the manager/sponsor).
- The working group constituted by SEBI has pointed out that the current restriction on investing only in start-ups prevents angel funds from exercising pre-emptive rights in their portfolio companies once those companies are no longer considered start-ups. Therefore, it has been proposed that angel funds be permitted to make follow-on investments in their existing portfolio investee companies (which are no longer start-ups), subject to the following conditions:
- Only investors who had contributed in the original investment in the portfolio investee company when it was a start-up may contribute;
- The percentage of the post-issue beneficial interest of the angel fund in the investee company should not exceed the percentage of its interest prior to the follow-on investment since the follow-on investment is only meant to protect and preserve the value of their initial investments.
- The follow-on investment shall not exceed the maximum permissible investment limit in an investee company (proposed to be INR 25 crore).
- Currently all investments by angel funds are locked-in for a period of 1 year. It is proposed that this period be reduced to 6 months.
- Currently, Regulation 19(G)(2) of the AIF Regulations requires the investment manager and/or sponsor of an angel fund to maintain a continuing interest of at least 2.5% of the AIF’s corpus, or INR 50 lakh, whichever is lesser. However, due to the deal-by-deal structure of angel funds, there is a lack of clarity on how this continuing interest should be maintained across individual investments, particularly in ensuring the manager/sponsor’s “skin-in-the-game.” Therefore, it has been proposed that the sponsor/manager should maintain a minimum continuing interest in each investment, rather than at the fund level. The Consultation Paper has proposed a minimum of 0.5% of the investment amount or INR 1,00,000 whichever is higher.
- Since investors in an angel fund can opt out of any investment, each investment by an angel fund is an independent “scheme”. Reg 19(E)(1) of AIF Regulations requires all angel funds to file a term sheet with SEBI containing material information before launching any “scheme”. The term sheet format specified in the SEBI Master Circular of May 07, 2024, requires details about each investee company for which an investment is proposed. In the case of AIFs other than angel funds, the term “scheme” means a blind pool of multiple investments. Currently angel funds file the term sheet only for informational purposes and other categories of AIFs do not need to file any document with SEBI before making investments. The Consultation Paper has proposed that the requirement of filing a term sheet be removed altogether.
- The Consultation Paper has proposed that a PPM template be provided for angel funds. Further, a merchant banker’s intervention shall be required to file PPMs of angel funds with SEBI, just as in the case of other AIFs.
- PPM Audit shall be required for angel funds having total investments more than INR 100 crore.
- Angel funds shall conduct their first close, by on-boarding a minimum of 5 accredited investors, within 12 months from the date of SEBI’s communication for taking the PPM on record.
- For new angel funds, the proposals in the Consultation Paper shall be made applicable from the date of notification of the amendments to AIF Regulations. For existing angel funds, a period of one year shall be provided. Post such one year period, angel funds should ensure that the investments are made only out of capital contributed by accredited investors. During the aforesaid one-year period, angel funds, having non accredited investors, shall ensure that the investment opportunity is not offered to more than 200 investors.
The Consultation Paper can be accessed here.
We hope you have found this information useful. For any queries/clarifications please write to us at insights@elp-in.com or write to our authors:
Vinod Joseph, Partner – Email – vinodjoseph@elp-in.com
Paridhi Jain, Associate, Email – paridhijain@elp-in.com
