Table of Contents
Chapter 11: Investment Strategies, Investment Process and Governance of Funds
The operational success of an Alternative Investment Fund manager depends on the rigor of its deal origination and diligence architecture. Generating superior risk-adjusted alpha requires originating high-quality deal flow and subjecting candidate enterprises to exhaustive investigative scrutiny before deploying investor capital.
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| AIF INVESTMENT PROCESS WORKFLOW |
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| [ SOURCING & INITIAL SCREENING ] |
| • Proprietary founder networks, investment banks, venture scouts. |
| • Preliminary review against fund mandate; preparation of Preliminary Investment Memo (PIM). |
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| v |
| [ TERM SHEET EXECUTION ] |
| • Non-binding valuation, indicative structure, governance terms, and exclusivity period. |
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| v |
| [ MULTI-DISCIPLINARY DUE DILIGENCE REVIEW (DDR) ] |
| • Business & Commercial DD • Financial & Tax Accounting DD |
| • Legal & Regulatory Title DD • ESG & Environmental Diligence |
| • Forensic & Integrity DD • Technology & IP Architecture DD |
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| [ FINAL INVESTMENT COMMITTEE (IC) APPROVAL ] |
| • Comprehensive Final Investment Memo (FIM) presented to IC. |
| • Formal vote and binding approval recorded in minutes. |
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| v |
| [ DEFINITIVE DOCUMENTATION & DISBURSEMENT ] |
| • Execution of SSA, SHA, and Debenture Trust Deeds; fulfillment of Conditions Precedent (CPs).|
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The Multi-Disciplinary Due Diligence Framework
- Commercial and Business Due Diligence: Evaluates market size (TAM/SAM/SOM), competitive moats, pricing power, customer cohort retention metrics, unit economics (LTV to CAC ratio), and sustainable industry growth drivers.
- Financial and Tax Diligence: Conducted by independent accounting firms to verify the quality of historical earnings (Quality of Earnings [QoE] report), normalize EBITDA for non-recurring expenses, detect hidden tax liabilities, and verify working capital cycles.
- Legal and Regulatory Diligence: Conducted by specialized corporate law firms to verify clean share capital capitalization tables (cap tables), review intellectual property (IP) assignments, examine material litigation, inspect labor law compliance, and confirm regulatory operating permits.
- Forensic and Integrity Diligence: Employs background intelligence investigations on promoters to uncover past bankruptcy proceedings, undisclosed related-party transactions, shell entity networks, or political affiliations.
- ESG (Environmental, Social, and Governance) Diligence: Assesses workplace safety standards, carbon footprints, supply chain labor ethics, and data privacy compliance.
Once the Investment Committee approves an investment and diligence confirms operational integrity, the legal counsel drafts and negotiates the Definitive Transaction Agreements. In Indian private equity and debt, these primarily consist of the Share Subscription Agreement (SSA) and the Shareholders' Agreement (SHA).
Primary Transaction Agreements
| Agreement | Legal Purpose & Core Scope | Key Negotiated Provisions |
|---|---|---|
| Share Subscription Agreement (SSA) | Regulates the primary issuance and purchase of new shares or convertible securities by the investee company to the AIF. | • Tranches of investment and subscription price. • Conditions Precedent (CPs) required prior to closing. • Comprehensive Representations & Warranties (R&Ws). • Specific Indemnities and liability caps. |
| Shareholders' Agreement (SHA) | Governs the ongoing relationship, voting conduct, management rights, and transfer of shares among the promoters and the AIF. | • Board composition and Observer appointments. • Affirmative Voting (Reserved) Matters. • Pre-emptive and Information Rights. • Transfer restrictions: ROFO, ROFR, Tag-Along, Drag-Along. • Liquidation Preference and Exit waterfalls. |
Hierarchy of Core Protective Covenants
- Affirmative Voting Rights (Reserved Matters): Critical corporate actions that cannot be approved or implemented without the explicit written affirmative consent of the AIF's nominee director (e.g., changing charter documents, taking on debt above agreed thresholds, related-party transactions, executing strategic M&A).
- Broad-Based Weighted Average Anti-Dilution Formula: Protects the fund against dilution in the event of a future down-round:
$$P_2 = P_1 \cdot \left[ \frac{A + B}{A + C} \right]$$
Where $P_1$ is existing conversion price, $P_2$ is new adjusted conversion price, $A$ is pre-round shares outstanding, $B$ is shares purchasable at $P_1$ with new proceeds, and $C$ is actual new shares issued.
- Tag-Along vs. Drag-Along Rights: Tag-Along rights allow the AIF to join a promoter's equity sale on identical terms; Drag-Along rights allow the AIF to force promoters to sell 100% of the enterprise to a strategic buyer if an agreed IPO is not achieved within a contract window (e.g., 5 years).
- Liquidation Preference: A 1x Non-Participating Liquidation Preference guarantees that the AIF recovers 100% of its invested capital before common equity holders receive any proceeds upon liquidation or sale.
Category III AIFs operate in active equity and derivative markets, deploying sophisticated trading strategies that require robust governance.
Core Strategy Verticals
- Long/Short Equity: Maintains core long positions in fundamentally superior companies while holding short positions in overvalued equities or shorting index futures to hedge tail risk.
- Equity Market Neutral (EMN): Balances long and short exposures to achieve a net beta of zero ($\beta_{\text{net}} \approx 0$), isolating pure stock-picking alpha.
- Quantitative / Statistical Arbitrage: Algorithms exploit mean-reversion anomalies across co-integrated stock pairs.
- Convertible & Merger Arbitrage: Delta-neutral convertible bond hedging and capturing merger spreads in announced corporate takeovers.
SEBI Co-Investment Regulations and Governance
- Pari Passu Terms: Co-investments by investors in portfolio companies of an AIF must be routed through a dedicated Co-Investment Scheme or specialized PMS route. Co-investors must invest on terms no more favorable than the main fund, with exits executed on a pro-rata basis at identical valuations.
- Investment Committee Fiduciary Governance: The IC must record detailed minutes of all investment and exit decisions, maintaining strict records of risk limit adherence and conflict of interest resolutions.