Framework for AIFs to make co-investment within the AIF structure
Chapter 6 - Framework for AIFs to make co-investment within the AIF structure
Category I and Category II AIFs are permitted to offer a co-investment facility to Accredited Investors.
This facility is provided by launching a separate Co-investment Scheme, also referred to as a “CIV Scheme”, under the AIF Regulations.
The CIV Scheme allows eligible investors to make co-investments alongside the AIF in investee companies.
This CIV Scheme route is in addition to the existing co-investment facility available through Co-investment Portfolio Managers.
The existing alternative route is provided under the SEBI (Portfolio Managers) Regulations, 2020.
So, there are broadly two routes for co-investment:
CIV Scheme route under the AIF Regulations.
PMS route through Co-investment Portfolio Managers under the PMS Regulations.
The CIV Scheme route is specifically available to Accredited Investors.
Understanding the PMS Route
The PMS route allows an investor in an AIF to make a separate investment directly into an investee company through a Co-investment Portfolio Manager (CIPM).
The route operates under the SEBI (Portfolio Managers) Regulations, 2020.
A Co-investment Portfolio Manager (CIPM) is a Portfolio Manager registered with SEBI specifically for providing co-investment services.
The AIF invests in an investee company, and an eligible investor of that AIF can separately invest in the same investee company through the CIPM.
The investor's investment is therefore outside the AIF's portfolio, because it is made through the Portfolio Manager.
6.1
Under Regulation 17A(7) of the AIF Regulations, co-investment through a CIV Scheme can be carried out by the Manager of a Category I or Category II AIF.
The Manager must carry out such co-investment:
In the manner specified by SEBI.
Subject to the conditions specified by SEBI from time to time.
So, Regulation 17A(7) provides the legal basis for co-investment through a CIV Scheme.
However, the Regulation itself does not contain all the operational details.
SEBI separately specifies the operational modalities and conditions that must be followed by the Manager while carrying out such co-investments.
6.1.1
Managers of AIFs can facilitate co-investment for an investor in an investee company.
Such co-investment can be made through either of two routes:
(a). PMS Route
Co-investment is made through a Co-investment Portfolio Manager (CIPM).
The route is governed by the SEBI (Portfolio Managers) Regulations, 2020.
(b). CIV Scheme Route
Co-investment is made through a Co-investment Vehicle (CIV) Scheme.
This route is governed by the AIF Regulations and SEBI's specified conditions.
6.1.2
Under Regulation 17A(2) of the AIF Regulations, the Manager of an AIF is required to file a Shelf Placement Memorandum.
SEBI has prescribed a template for the Shelf Placement Memorandum, which is provided in Annexure 10.
The Shelf Placement Memorandum contains important information relating to the co-investment arrangement.
It includes, among other things:
(a). Principal Terms of Co-investments
Sets out the key terms and conditions governing co-investments.
(b). Governance Structure
Explains the governance framework applicable to the co-investment arrangement.
Specifies how the co-investment structure will be managed and governed.
(c). Regulatory Framework
Sets out the regulatory framework applicable to co-investments.
Helps investors understand the regulatory requirements governing the CIV Scheme.
6.1.3
Each CIV Scheme must have a separate bank account.
Each CIV Scheme must also have a separate demat account.
The assets of one CIV Scheme must be kept separate from the assets of other CIV Schemes.
This is known as ring-fencing of assets.
So, the assets of one CIV Scheme cannot be mixed or used with the assets of another CIV Scheme.
6.1.4
An investor may make co-investments in an investee company through multiple CIV Schemes.
However, there is a maximum limit on the total co-investment that the investor can make across all such CIV Schemes.
The total co-investment cannot exceed 3 times the investor's contribution to the investment made by the relevant AIF in that investee company.
Exemption from 3x Co-investment Limit
The 3x co-investment limit does not apply to certain specified investors.
These investors may invest any amount in an investee company through CIV Schemes.
The exempted investors are:
(a). Multilateral or Bilateral Development Financial Institutions
Institutions established to provide development financing, either jointly by multiple countries or between two countries.
(b). State Industrial Development Corporations
Industrial development corporations established by State Governments.
(c). Government-owned or Government-controlled Entities
Entities that are:
Established by the Central Government;
Established by a State Government;
Owned or controlled by the Central Government;
Owned or controlled by a State Government; or
Established, owned or controlled by the Government of a foreign country.
This category specifically includes:
Central Banks
Sovereign Wealth Funds
6.1.5
An investor of an AIF scheme may sometimes be:
Excused from contributing to an investment.
Excluded from contributing to an investment.
In default of its contribution towards an investment.
If this happens in relation to an investee company, that investor cannot subsequently co-invest in the same investee company.
6.1.6
The Manager must ensure that the CIV Scheme does not make investments that would circumvent restrictions applicable to its investors.
(a). Investment not permitted directly
The CIV Scheme cannot make an investment that would result in its investors indirectly acquiring or holding an interest/exposure that they are not permitted to acquire or hold directly.
Example:
Investor A is prohibited from directly investing in a particular company.
Investor A cannot use the CIV Scheme to indirectly obtain exposure to that company.
The CIV Scheme therefore cannot make that investment on behalf of Investor A.
(b). Investment requiring additional regulatory disclosure
The CIV Scheme cannot make an investment that would require the investor to make additional regulatory disclosures if the investor had invested directly.
Example:
Assume Investor A, if it directly acquires shares in XYZ Ltd., would cross a regulatory disclosure threshold.
Direct investment would therefore require Investor A to make an additional regulatory disclosure.
Investor A cannot avoid this disclosure requirement by making the investment through a CIV Scheme.
So, the CIV Scheme cannot make such an investment where it would create this additional disclosure obligation for Investor A.
(c). Investee company cannot receive direct investment
The CIV Scheme cannot invest in an investee company where the investee company is not permitted to receive investment directly from the concerned investor.
Example:
Investor A is not permitted to invest directly in XYZ Ltd. because of a restriction applicable to that investor or to XYZ Ltd.
Investor A cannot overcome this restriction by investing in XYZ Ltd. indirectly through a CIV Scheme.
So, the CIV Scheme cannot make that investment for Investor A.
6.1.7
A CIV Scheme cannot borrow funds for making investments.
The prohibition applies to both:
Direct borrowing by the CIV Scheme.
Indirect borrowing through another arrangement or structure.
A CIV Scheme also cannot engage in any form of leverage.
6.1.8
Investors in a CIV Scheme have rights in the investments made by the CIV Scheme.
They are also entitled to receive a share of the proceeds generated from those investments.
Generally, these rights and proceeds are distributed pro-rata according to each investor's contribution to the CIV Scheme.
Example
CIV Scheme has two investors:
Investor A contributes ₹60 crore.
Investor B contributes ₹40 crore.
Total contribution = ₹100 crore.
Therefore:
Investor A has 60% interest.
Investor B has 40% interest.
If the CIV Scheme earns ₹20 crore from an investment:
Investor A would generally receive ₹12 crore.
Investor B would generally receive ₹8 crore.
Exception: Carried Interest
The pro-rata distribution is subject to carried interest or any additional return, irrespective of what it is called.
A portion of the return may be shared with:
Sponsor of the AIF.
Manager of the AIF.
Employees of the Manager.
Directors of the Manager.
Partners of the Manager.
So, investors do not necessarily receive 100% of the proceeds strictly in proportion to their contribution, because:
The agreed carried interest or additional return may first be allocated to the above persons.
6.1.9
Any expenses associated with a co-investment must be shared between:
The scheme of the AIF.
The CIV Scheme.
The expenses must be divided proportionately based on the ratio of their respective investments.
6.1.10
A CIV Scheme must comply with any implementation standards formulated by the Standard Setting Forum of AIFs (SFA).
These implementation standards are formulated by the SFA in consultation with SEBI.
The purpose of these standards is to ensure that investments made through CIV Schemes are for bona-fide purposes.
They are also intended to prevent the flexibility provided to CIV Schemes from being misused.
SEBI provides flexibility to AIFs and their Managers to facilitate co-investments through CIV Schemes.
However, this flexibility cannot be used to:
Circumvent regulatory requirements.
Structure investments for improper purposes.
Give investors an unfair or inappropriate advantage.
Therefore, the SFA may formulate implementation standards to establish practical standards and safeguards for the operation of CIV Schemes.
6.2
Any implementation standards formulated by the Standard Setting Forum of AIFs (SFA) in consultation with SEBI must be adopted by:
AIFs.
Managers of AIFs.
Key Management Personnel (KMPs) of AIFs.
These standards must be followed to ensure compliance with the provisions of the relevant chapter of the AIF Regulations.
The implementation standards are therefore not merely guidance. Once applicable, AIFs, their Managers and KMPs are required to adopt them for compliance.
Publication of Standards
The implementation standards formulated by the SFA must be published on the websites of the industry associations that are members of the SFA.
These associations are:
Indian Venture and Alternate Capital Association (IVCA)
PE VC CFO Association
Trustee Association of India
