Five-year limit for angel funds to drawdown committed capital – can it be extended?
At the time of LVA’s application to SEBI for its informal guidance, LV Fund was about to complete five years from the date of its registration. Regulation 19D(3) of the Securities and Exchange Board of India (Alternative Investment Funds) Regulations, 2012 (AIF Regulations) states that each angel investor who invests in an angel fund should invest a minimum of INR 25, Lakh and such investment has to be made within 5 (five) years. LVA informed SEBI that some angel investors have under-utilized the threshold amount of INR 25 Lakh within the period of 5 (five) years. LVA queried if the aforementioned time limit of 5 (five) years could be extended any further?
SEBI responded in its Guidance that the 5 (five) year period for making investments cannot be extended since the AIF Regulations does not contain any specific provision which permits such extension.
It is interesting to note that only some of the investors in the LV Fund have under-utilized their right to invest in the fund. This is probably because, unlike other categories of AIFs, angel funds allow their investors to opt out of investments. So, even if an investor has made a capital commitment of INR 25 Lakh, it is possible that the investor ends up investing less than such amount. The mandate in Regulation 19D(3) of the AIF Regulations that ‘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’ is at odds with the angel investors’ freedom to opt out of investments given in Regulation 19G(3) of the AIF Regulations. However, SEBI has not commented on or found fault regarding the fact that the LV Fund has not complied with Regulation 19D(3) of the AIF Regulations with respect to some of its angel investors. Thus, it is implied that as long as an angel fund obtains a capital commitment of not less than INR 25Lakh from each angel investor, it would be in compliance with Regulation 19D(3) of the AIF Regulations even if such amount is not drawndown within 5 (five) years of registration of the angel fund.
Would it be possible to apply the principles from the aforementioned response from SEBI to funds other than angel funds? In case of AIFs other than angel funds, the minimum required investment for each investor is INR 1Crore. Regulation 10(c) of the AIF Regulations states that ‘the Alternative Investment Fund shall not accept from an investor, an investment of value less than INR one Crore. However, investors in AIFs other than angel funds cannot opt out of investments’. It is possible that an AIF may not drawdown the entire capital commitment from its investors and so for some investors the amount invested in the AIF may be less than INR 1Crore. Applying the principles from the aforementioned response from SEBI, it may be said that such funds would not be in violation of Regulation 10(c) of the AIF Regulations as long as the AIF had obtained a capital commitment of not less than INR 1 Crore from each investor.
Breach of minimum investment threshold for follow-on investments
Regulation 19F(2) of AIF Regulations requires the investment by an angel fund in any investee company to not be less than INR 25 Lakh and not more than INR 1 Crore.
LVA informed SEBI that there have been scenarios when investee companies of LV Fund (in which the LV Fund has invested a sum not less than the minimum amount required under Regulation 19F(2) of AIF Regulations) restructured to form a new legal entity (for reasons such as flipping to foreign jurisdictions, change in business line etc.,) and offered LV Fund a stake in the newly incorporated entity for a nominal investment amount which would be less than INR 25 Lakh. If LV Fund accepted the offer to invest in the new legal entity, it would end up with a stake in the new entity (that would be equal to its original shareholding percentage in the new legal entity) and the Fund’s shareholding in the old entity would be zeroed down. To comply with the regulation 19F(2) of AIF Regulations, the Fund often rejects the offer to participate in the new company or subscribes INR 25 Lakh to get shares which are valued at a few thousand rupees.
SEBI has responded to the effect that in such circumstances (where “no new transaction of fresh investment is being made”), “then the requirement of minimum INR 25 Lakh investment may not be applicable” (sic text in “quotes”).
It seems reasonable that if the restructuring of an investee company gives an AIF the option to invest less than INR 25 lakh in the restructured company, it should be allowed to do so.
When does the obligation to file a revised term-sheet arise?
Since angel funds give their investors the right to opt out of investment, every investment made by an angel fund is a separate scheme. As per para 15.3 of the Master Circular dated July 31, 2023, for AIFs, angel funds may launch schemes subject to filing of a Term Sheet (in the format as specified in Annexure 15 of the aforementioned Master Circular) containing material information regarding the scheme. Such Term Sheet has to be filed with SEBI within ten days of launching the scheme. Therefore, every time an angel fund makes an investment, it has to file a term sheet with SEBI as per para 15.3 of the aforementioned Master Circular.
LVA has queried when the obligation to file the revised term-sheet arises.
Sometimes, after an angel fund files a term sheet, the commercials of the investment (such as the investment amount) may change. LVA has queried if a revised term sheet is required to be filed with SEBI when such changes occur. Does a revised term sheet have to be filed for every minor change in the details contained in the term sheet filed with SEBI or only for relevant material changes? Further, is there any specific time period within which the revised term sheet can be filed?
SEBI has responded that “considering that changes in term sheet are pursuant to change in terms of investment, Angel Funds are required to submit the (revised) term sheet and material changes in the same, if any, as soon as the said change has happened and in any case, before making any investment pursuant to the revised terms of investment.”
We interpret SEBI’s response to mean that a revised term sheet has to be filed if the changes to the commercial terms are “material” changes.
Creation of Sub-Schemes
LVA queried if it can create sub-schemes under existing Schemes.
SEBI has refused to respond to the above query on the ground that this query does not cite any applicable legal provision. It says “As per paragraph 8(iv) of the Informal Guidance Scheme, SEBI may not respond to requests where the applicable legal provisions are not cited by the applicant. Since the applicable legal provisions are not cited and the AIF Regulations do not have any reference to the concept of ‘sub-schemes’, no response has been provided for Query IV.”
It is unfortunate that SEBI has refused to respond to this query. It is true that the AIF Regulations do not contain any reference to “sub-schemes”. However, the reason for the query is exactly because the AIF Regulations are silent on this point. LVA did not cite any reason why it wanted to create sub-schemes. It is possible that if LVA had given examples to illustrate its need to create sub-schemes, SEBI might have responded to the query, one way or the other.
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