Chapter 15: SEBI (Alternative Investment Funds) Regulations, 2012

The SEBI (Alternative Investment Funds) Regulations, 2012 govern privately pooled investment vehicles that collect funds from sophisticated institutional and high-net-worth investors for deployment under defined investment policies.

Statutory Definition (Regulation 2(1)(b))

An Alternative Investment Fund (AIF) is any fund established or incorporated in India in the form of a trust, company, LLP, or body corporate that:

1. Is a privately pooled investment vehicle collecting funds from investors, whether Indian or foreign;
2. Invests in accordance with a defined investment policy for the benefit of its investors;
3. Is not covered under SEBI Mutual Fund Regulations, Collective Investment Schemes, or family trusts.

Classification into Three Distinct Categories

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|                        ALTERNATIVE INVESTMENT FUNDS (AIFs)                        |
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| CATEGORY I AIF (Positive Spillover / Early Stage / Social & Infra Growth):        |
| - Venture Capital Funds (VCFs), Angel Funds, SME Funds                            |
| - Social Impact Funds, Infrastructure Funds                                       |
| - Concessions: Pass-through tax status, government incentives                     |
|                                                                                   |
| CATEGORY II AIF (Standard Private Equity & Debt / No Operational Leverage):       |
| - Private Equity (PE) Funds, Debt Funds, Real Estate Funds, Fund of Funds         |
| - Cannot borrow or employ leverage except for short-term operational cash needs   |
|                                                                                   |
| CATEGORY III AIF (Complex Trading / Hedge Funds / Leverage Permitted):            |
| - Hedge Funds, Long-Short Equity Funds, Commodity Arbitrage Funds                 |
| - Permitted to employ leverage up to 2 times (2x) the fund NAV                    |
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The AIF regulations establish structural safeguards calibrated for sophisticated investors.

Structural Parameters of AIF Schemes

• Minimum Investment Ticket Size: Minimum ₹1 Crore per investor (reduced to ₹25 Lakhs for Angel Funds, and for employees/directors of the AIF or Manager).
• Minimum Scheme Corpus: Every AIF scheme must have a minimum aggregate corpus of ₹20 Crores (reduced to ₹5 Crores for Angel Funds).
• Maximum Investors: An AIF scheme cannot have more than one thousand (1,000) investors (Angel Fund schemes capped at two hundred (200) angel investors).

Continuing Sponsor Commitment (Skin-in-the-Game)

The Sponsor or Investment Manager must maintain a continuing financial stake in the AIF:

• Category I & II AIFs: Minimum 2.5% of the corpus or ₹5 Crores, whichever is lower.
• Category III AIFs: Minimum 5% of the corpus or ₹10 Crores, whichever is lower.
• Angel Funds: Minimum 2.5% of the corpus or ₹50 Lakhs, whichever is lower.

Scheme Tenor & Diversification Rules

• Closed-Ended Mandate: Category I and Category II AIFs must be closed-ended with a minimum tenure of three (3) years. Tenure extension is permitted up to a maximum of two (2) years, subject to approval by at least two-thirds (66.6%) of unitholders by value. Category III AIFs can be open-ended or closed-ended.
• Diversification Caps: Category I and II AIFs cannot invest more than 25% of their investable funds in a single investee company. Category III AIFs cannot invest more than 10% in a single investee company.

SEBI has introduced major reforms to enhance transparency and corporate governance across AIFs.

Mandatory Dematerialisation of AIF Units

• All AIFs must issue units exclusively in dematerialized (demat) form through NSDL and CDSL, ensuring safe custody, seamless secondary transfers, and auditability.

Valuation Framework (Regulation 23)

• Category I and II AIFs must conduct independent valuation of portfolio assets at least once every six (6) months by an independent registered valuer.
• Category III AIFs must calculate and disclose the NAV of the fund to investors at least quarterly (for closed-ended funds) or monthly (for open-ended funds).

Co-Investment Portfolio Management

To eliminate conflicts where select favored investors received preferential co-investment allocations alongside the fund:

• Co-investment by investors in investee companies must be executed exclusively through a specialized Co-Investment Portfolio Management Services (PMS) route managed by the AIF Manager, subject to identical entry and exit pricing.

AIFs operate under a specialized disclosure-driven compliance framework designed to ensure that the Manager adheres strictly to the declared investment strategy.

Private Placement Memorandum (PPM) Audit

Every AIF must conduct an annual PPM Audit by an independent external chartered accountant or legal firm:

• Verifies that the actual investments executed by the fund comply with the investment strategy, sectoral focus, and risk limits disclosed in the PPM;
• Evaluates whether expenses charged to the fund (management fees, setup expenses, audit costs) conform to disclosed caps;
• The PPM audit report must be submitted to the Board of the Manager, the Trustee, and SEBI annually.

Specialized Norms for Angel Funds (Sub-Category of Cat I)

• Angel Investor Eligibility: An individual who has net tangible assets of at least ₹2 Crores (excluding principal residence), or a corporate entity with net worth of at least ₹10 Crores.
• Investment Focus: Can invest only in venture capital undertakings that are startups incorporated within the preceding ten (10) years with turnover not exceeding ₹100 Crores.
• Deal Allocation: Minimum investment in a startup is ₹25 Lakhs, capped at a maximum of ₹10 Crores per company.

Quarterly Reporting to SEBI

Every AIF must submit a quarterly report to SEBI through the SEBI Intermediary Portal within fifteen (15) calendar days from the end of each quarter, detailing capital drawdowns, cumulative investments, sector exposures, and leverage utilization.

Because Category I and II AIFs invest primarily in illiquid, unlisted securities, the regulations prescribe explicit exit and winding-up mechanisms.

Scheme Tenure Extension

• The tenure of a closed-ended AIF scheme may be extended for up to two (2) years, subject to the approval of at least two-thirds (66.6%) of the unitholders by value.
• Any further extension beyond two years is strictly prohibited under standard rules.

Liquidation Period & Dissolution (Regulation 29B)

Where unlisted portfolio assets remain unsold at the end of the scheme tenure (including permitted extensions):

1. One-Year Liquidation Period: The AIF is granted a one-year liquidation window to sell remaining assets.
2. In-Specie Distribution: If assets cannot be sold, the Manager may distribute the unlisted securities directly ("in-specie") to unitholders, provided approval of at least 75% of unitholders by value is obtained.
3. Liquidation Scheme: Alternatively, the AIF can transfer unsold illiquid assets into a specialized "Liquidation Scheme" with unitholder consent, allowing the original scheme to formally dissolve and close its accounts.