PE and VC funds with five or fewer investors attract Sebi’s attention

Private equity (PE) and venture capital (VC) funds holding money for 5 investors or less have caught the eye of the capital market regulator.

Do these funds act as vehicles for family offices and promoters? Are the managers of such funds under the influence of a handful of wealthy investors? Is regulatory interest a precursor to a general rule requiring more investors?

Although the regulator’s intent is unclear, the Securities & Exchange Board of India (Sebi) sent an email on Sept. 12 — a week after questioning PE and VC funds about their valuation practices. — asked for various information about the funds formed with a small club of investors, two senior industry officials told ET.

These funds must give details of investors in a plan: name of investors; whether it is an individual, a company, a limited liability company or a trust; the country of the investor; the amount he has committed and the amount of funds raised. They must also submit the name of the beneficiary company, its country of origin, the nature of its activity and the instrument issued (shares, debt, convertible, etc.) to raise funds. Details must be provided for each scheme of an alternative investment fund (AIF) — the regulatory term for PE, VC and angel funds. In addition, the name of a contact person in each fund as well as the mobile phone number must be shared with Sebi.

“Usually, funds with less than five contributors (excluding sponsor and manager) are captive in nature. We have seen many family offices, large investors and corporations use AIFs to hold stakes in companies. Probably, they don’t want to reveal their identity. The beneficiary companies also prefer the name of a single AIF in the table of limits rather than five different investors in the fund… But we are not sure why Sebi asked for the information. Maybe he wants to know more about these captive funds,” said a person with a fund trustee.

According to Tejesh Chitlangi, Senior Partner at IC Universal Legal, while AIFs, unlike mutual funds, have no broad base requirements, SEBI could look into introducing some form of broad base investor for AIFs. FIA. “But such a rule, if considered, should not be as strict as the 20/25 requirement prescribed for mutual funds, because mutual funds raise retail funds unlike AIFs which approach large investors through privately placed AIFs,” Chitlangi said.

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MFs must follow a 20/25 rule whereby each system must have a minimum of 20 investors with no single investor holding 25% units in the system. An AIF, however, may even have a single investor, although no more than a quarter of the fund’s corpus may be invested in a single entity.

Moreover, it can be perceived that a small group of investors ends up influencing the fund manager and the construction of the portfolio. “But such concern may not be well placed as funds need to make regulatory disclosure in case investors have a role in approving investment decisions, including through vetting exercises. A single investor fund is not unusual as India is typically accessed through master-feeder type structures, where in addition to the feeder, the master fund may only have a stake of group of sponsors,” said Richie Sancheti, founding partner of law firm Richie Sancheti Associates (RSA).

In the master-feeder structure, a pool of funds can be created in a financial center in Mauritius, Delaware, Singapore or Gift City, with subscriptions from a number of investors in all markets, there may be having a single master entity investing in the AIF in India.

“Sebi requests data for certain analyses. This will be used to make decisions on the political front,” said a person close to the development.

Sebi has compiled a wide range of data on AIFs, likely given the growing importance of their importance as investment vehicles. Often, such an exercise can precede regulatory changes. On September 6, the regulator had asked AIFs to disclose their valuation methodologies – a request that is growing in importance as most funds are closed-end vehicles investing in unlisted securities of startups.

A week earlier, Sebi had asked the funds to clarify whether the fund’s sponsor and manager were owned and controlled by foreign residents. Even in the latest communication (dated September 12), funds with five or fewer investors were asked to report whether their sponsors are controlled by non-residents. A sponsor contributes Rs 5 crore or 2.5% of the fund, whichever is lower.

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