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The new regulations impact PE and VC funds registered under the Alternative Investment Funds 1 & 2 categories and hedge funds registered under the AIF 3 category in India

The regulations state that an AIF shall not invest more than 25% of the investable funds in an investee company directly or indirectly

The new regulations are applicable from this year but could require PE and VC funds to realign their existing investments as well

The Securities and Exchange Board of India’s new regulations, which put a threshold on the amount that private equity (PE) and venture capital (VC) funds can invest in a company or another investment vehicle, are likely to force these funds to realign some of their investments. 

The new regulations impact PE and VC funds registered under the Alternative Investment Funds 1 & 2 categories and hedge funds registered under the AIF 3 category in India. 

The regulations state that an AIF, “shall invest not more than 25% of the investable funds in an investee company directly or through investment in the units of other alternative investment funds.”

Earlier, an AIF could invest more than 25%, directly or indirectly, in an investee company. For Category 3 AIFs, the limit is now capped at 10%. 

According to an ET report, by the end of 2019, fund managers were sitting on huge piles of capital they had raised. With the onset of the Covid pandemic, “Many PE and VC funds invested large sums in a few companies, some even invested the money in their existing investment companies or in some cases existing funds,” a security lawyer told the publication. 

The new regulations are applicable from this year but could require PE and VC funds to realign their existing investments as well. 

In March, the finance ministry through a notification allowed domestic private provident funds to invest up to 5% of their surplus in Alternative Investment Funds (AIFs). 

The exposure to a single AIF should not exceed 10% of the particular AIF’s total size and up to 51% of category II AIF

This development means that private provident funds, superannuation funds and gratuity funds will now be able to participate in the venture capital (VC) investment ecosystem. AIFs put money in sectors that are not traditional (for example, equities or fixed income). AIFs and industry stakeholders have welcomed the move as it will offer more capital to startups in India.