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SEBI signals more flexibility for angel and venture funds investing in startups

The Securities and Exchange Board of India (SEBI) proposes to remove certain restrictions and provide regulatory flexibility for venture capital and angel funds investing in startups.

As per SEBI’s AIF Regulations, venture capital funds are those that invest in “in new products, new services, technology or intellectual property right based activities or a new business model.” These Cateogory I AIFs also receive tax benefits and incentives from the government since they “are generally perceived to have positive spillover effects on economy,” it said.

The board of the markets regulator on Thursday approved to amend regulations for Alternative Investment Funds (AIFs), bringing in five changes to the  regulations, impacting venture capital funds and angel funds in particular:

  1. Introduce the definition of ‘startups’ as specified Government’s into the AIF regulations for angel funds
  2. Allowed venture funds to invest in sectors that were earlier restricted
  3. Provide clarity on scope of responsibilities of managers and members of Investment Committees
  4. Prescribe a Code of Conduct to be followed by all AIFs, their management and investment committees.
  5. Allow AIFs, including Fund of Funds, to invest in units of other AIFs and directly in securities of investee companies.

Last week, the Finance Ministry amended the AIF regulations allowing provident, superannuation, and gratuity funds to invest up to 5% of their corpus in units issued by AIFs, including venture capital funds. This would attract some long-term institutional capital for all AIFs

Incentives for angel and venture funds

Category I AIFs are infrastructure funds, SME funds, venture capital funds, and social venture capital funds. Angel funds are a sub-category of VC funds and can presumably be invested in. Debt funds are also a kind of Category I fund. Real estate funds, private equity funds, funds for distressed assets, etc. are registered as Category II AIFs.

According to legal experts that spoke to MediaNama, the decision to bring the Government’s definition for angel funds and to remove restrictions for venture capital funds will channelise more funding to such companies.

Prashaant Vikram Rajput, Partner at White & Brief Advocates & Solicitors said that existing venture capital funds already have the ability to invest in startups. “The rationale for inclusion of the definition of “start-up” as provided by the government is to determine with specificity as to which entities shall qualify as start-ups for attracting investments from angel funds,” he said.

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A venture capital undertaking is restricted from operating in gold financing, non-bank lending, activities not permitted under the Industrial Policy and other activities that SEBI specifies. With the removal of the list of restricted activities/sectors from the definition of “venture capital undertaking”, venture capital funds shall have more flexibility in having exposure to these sectors/activities through their investment exposure in venture capital undertakings”—Prashaant Vikram Rajput, Partner

Self-regulatory model for AIFs

SEBI says it will prescribe a Code of Conduct for AIFs, their trustees, directors, partners, managers, members of the investment community and other executives.  The legal experts told MediaNama that the government and the regulator seem to be signalling a step back from over-regulating the financial services sector as a whole, and by extension they are proposing a self-regulatory model for venture capital funds.

Hemang Parekh, Partner at DSK Legal said that the intention is to start making it flexible for fund managers to raise funds and invest in startups.

“The conclusion of the SEBI board meeting seems to suggest that the regulator is making a more investor friendly environment for AIFs, both Cateogry I and Category II. This is being done to encourage AIFs to have a more robust base of portfolio companies and at the same time providing for a higher degree of self-governance for fund and fund managers”—Hemang Parekh, Partner at DSK Legal

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