SEBI to ease investment norms for venture capital and angel funds

With the concept of Atmanirbhar Bharat permeating the finance minister’s speech during the Union Budget 2021 session, the Securities and Exchange Board of India (SEBI) seemed to resonate the sentiment in its board meeting dated 25 March 2021, when the regulator decided to ameliorate investment conditions for venture capital funds and angel funds by proposing amendment to the SEBI (AIF) Regulations 2012.

Under the AIF regulations, venture capital funds are alternative investment funds, registered as Category I AIFs and investing primarily in unlisted securities of startups, emerging or early-stage venture capital undertakings that are mainly involved in new products or services, technology or intellectual property right-based activities, or new business models. 

Angel funds are a sub-category of venture capital fund that raise funds from angel investors and invest in accordance with the investment norms provided under the AIF regulations. 

The underlying criterion espoused under the AIF regulations for extending beneficent regulatory treatment towards Category I AIFs is that such funds are “generally perceived to have positive spillover effects on economy and for which SEBI or government of India or other regulators in India might consider providing incentives or concessions”.

Now, in its two-fold amendment handout for venture capital funds and angel funds, SEBI has proposed to provide a definition of the term startup in the AIF regulations, which shall be as specified by the government of India for the purpose of investment by angel funds. 

Presently, AIF regulations permit angel funds to invest in venture capital undertakings, which, inter alia, comply with the criteria regarding the age of the venture capital undertakings/startup issued by the Department of Industrial Policy and Promotion vide notification dated 17 February 2016, or such other policy in this regard. 

However, there is no definition of the term startup under the extant AIF Regulations. With the amendment bringing in the definition of startup in the AIF regulations, concessions granted to startups by various regulators will be aligned with permissibility of investment by venture capital funds and angel funds in such enterprises.

The regulator has also decided to remove the list of restricted business activities that may be conducted by a venture capital undertaking from the definition of venture capital undertakings, to accord flexibility to venture capital funds making investments in venture capital undertakings. 

A venture capital undertaking is defined under the extant AIF Regulations to mean a domestic company, which is not listed on a recognised stock exchange in India at the time of making investment; and is engaged in the business for (a) providing services, (b) production or manufacture of article or things, provided that the aforementioned businesses and activities do not include (i) non-banking financial companies (NBFCs), (ii) gold financing, (iii) activities not permitted under the industrial policy of government of India, and (iv) any other activity which may be specified by SEBI in consultation with the government of India.

With the removal of the restricted activities and sectors for venture capital undertakings, the investment universe for venture capital funds and angel funds will witness proliferation, thereby augmenting growth of venture capital funds and angel funds. 

While venture capital funds and angel funds have been seeing increased traction as an asset class by investors and investment managers in the past, their development vis-à-vis their brethren Category II AIFs and Category III AIFs has been fairly limited, largely on account of the limitations placed on investment by Category I AIFs under the AIF Regulations.

A growing number of fintech startups have business models focusing on granting credit access to underserved micro-enterprises, thereby rehauling the traditional NBFC and banking model in India, specially amidst the recent crises that has been experienced by the NBFC and banking sector. 

In light of this, relaxation in investment norms for venture capital funds and angel funds will help manoeuvre the much-needed funding to these fledgling fintech startups engaged in business activities related to financings.

It is notable that the central government has recently launched the Startup India Seed Fund Scheme, effective from 1 April 2021, and spanning over the period of next four years, aiming to provide financial assistance to startups. 

While the scheme will induce seed funding to startups, the proposed amendments to the AIF Regulations also ensure that investments by venture capital funds and angel funds are channelised effectively towards startups fulfilling the eligibility criteria charted out by the central government and that venture capital undertakings spread across varying sectors and activities are eligible to receive investment from AIFs. 

AIFs have exhibited prodigious growth as an alternative investment class in contrast to the traditional forms of funding that were prevalent in India before their inception. 

However, it is imperative that the inherent investment flexibility accorded to AIFs is preserved to ensure that they continue to act as a funding conduit for meeting capital requirements of startup enterprises, thereby catalysing their growth.

Divaspati Singh is partner and Ishita Khare is senior associate at Khaitan & Co. Views expressed are their own.

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