SVKM’S

NMIMS KPM SCHOOL OF LAW

A PROJECT SUBMITTED ON;

ALTERNATIVE INVESTMENT FUND (AIF) REGULATIONS

FOR ANGEL INVESTORS

IN COMPLIANCE TO PARTIAL FULFILLMENT OF THE MARKING

SCHEME, FOR SEMESTER 13 OF 2018-2019, IN THE SUBJECT OF
INVESTMENT LAW
SUBMITTED TO FACULTY:
SHRIKANT AITHAL

FOR EVALUATION
SUBMITTED BY:
RIDDHI TULSHIAN (A056)
B.B.A LL.B. (HONS.)
Research Problem
The scope and effectiveness of the earlier laws were not cut out to deal with the present market
difficulties and a lengthy procedure was followed which defeated the whole purpose of
investment laws.

Methodology
This research project has followed the doctrinal method of research, which requires the
researcher to acquire, arrange and then understand the data that is already available in the public
domain.1 Hence, this is a secondary method of data collection.

Abstract
Startup companies and emerging ventures often face difficulty in gathering funds for their
business entities. A group of investors who are wealthy and who are interested in new business
ideas having potential, always come to the rescue of such startup companies. These investors
are angels who not only provide funds at the crucial beginning of an entrepreneurship but also
help them with own expertise and contacts in the market. But the question that arises is: What
do such investors expect in return and how different are they from the traditional lenders? This
paper aims to study the concept of angel investors, their role in startup fund raising and the
merits and demerits of angel investment in a startup. The paper gives an overall view of the
concept of angel investors and angel funds and the Indian legal framework governing the
same.

Introduction
The growth in Venture Capital (“VC”) funding in India can be attributed to various factors.
Once the GoI started becoming more and more aware of the benefits of the VC investments
and the criticality for the growth of the different sectors such as software technology and
internet, favorable regulations were passed regarding the ability of various financial institutions
to invest in a VCF. Further, tax treatments for VCFs were liberalized and procedures were
simplified.
Subsequently, in 2012, SEBI took steps to completely overhaul the regulatory framework for
domestic funds in India and introduced the Securities and Exchange Board of India (Alternative

1
Roderick, M. (2014), “Source-usage within doctrinal legal inquiry: choices, problems, and challenges”
<http://www.bjutijdschriften.nl/tijdschrift/lawandmethod/2014/06/RENM-D-13-00003> Accessed on 29th
November 2016.
Investment Funds) Regulations, 2012 (“AIF Regulations”). Among the main reasons cited by
SEBI to highlight its rationale behind introducing the AIF Regulations was to recognize AIFs
as a distinct asset class; promote start-ups and early stage companies; to permit investment
strategies in the secondary markets; and to tie concessions and incentives to investment
restrictions. Here it is relevant to note that SEBI has adopted a practical grandfathering
approach which provides that funds that are already registered under the VCF Regulations
would continue to be governed by those regulations including for the purpose of raising
commitments up to their targeted corpus. However, existing venture capital funds are not
permitted to increase their targeted corpus. Further, new funds and existing funds that are not
registered under any regime would need to be registered under the AIF Regulations.

SEBI (Alternative Investment Funds) Regulations, 2012 (“AIF Regulations”) was amended by
the SEBI (Alternative Investment Funds) (Amendment) Regulations, 2013 (the
“Amendment”), with effect from 16 September 2013. While the Amendment provideed for
certain clarificatory and remedial provisions, its important feature was the introduction of
Angel Funds within the purview of “Category I AIF venture capital funds”, as defined in
the AIF Regulations. Taking on from the budgetary announcement of 2013-14 granting pass-
through status to Angel Funds, SEBI prescribed applicable requirements for Angel
Funds, as a distinct sub-category under venture capital funds. SEBI’s move to create a
distinctive category of AIFs for Angel Investors has twin objectives:
(i) a recognition that an Angel Fund has inherent differences in its functioning from
other funds; and
(ii) (ii) the need to ensure the authenticity of such investments and of the ability of such
investors to assume the high risks of these investments.

The Securities Exchange Board of India (SEBI amended the SEBI (Alternative Investment
Funds) Regulations, 2012 with respect to ‘Angel Funds’. The changes curb the complications
prevailing in the erstwhile regulations and extend certain relaxations with respect to angel
investment in India. The idea is to bring the regulations at par with the Startup India Action
Plan and to promote “Ease of Doing Business”. SEBI formed a working group comprising of
various angel investors and based on the recommendations of the working group, the SEBI
Board has approved following amendments to SEBI (Alternative Investment Funds)
Regulations, 2012 with respect to ‘Angel Funds’:
With this Amendment, Angel Funds had become demarcated as a distinct species and those
that meet the criteria can assume their distinct identity and operate in their own playing field.

What is an AIF?
An AIF means any fund established or incorporated in India in the form of a trust or a company
or an LLP or a body corporate which:
a. is a privately pooled investment vehicle which collects funds from investors, whether Indian
or foreign, for investing it in accordance with a defined investment policy for the benefit of its
investors; and
b. is not covered under the Securities and Exchange Board of India (Mutual Funds)
Regulations, 1996, Securities and Exchange Board of India (Collective Investment Schemes)
Regulations, 1999 or any other regulations of the Board to regulate fund management activities.

What is Category I AIF?

Category I AIFs are funds with strategies to invest in start-up or early stage ventures or social
ventures or SMEs or infrastructure or other sectors or areas which the government or regulators
consider as socially or economically desirable.
Under the AIF Regulations, the following funds are designated as sub- categories of Category
I AIFs - venture capital funds, SME funds, social venture funds, infrastructure funds and such
other AIFs as may be specified. In September 2013, SEBI introduced ‘angel investment funds’
as a sub-class of the venture capital fund sub- category.
AIFs which are generally perceived to have positive spillover effects on the economy and
therefore, SEBI, the Government of India or other regulators may consider providing incentives
or concessions shall be classified as Category I AIFs.

What is an Angel Fund and who are Angel Investors?

The definition of ‘Angel Fund’ is remarkably straightforward – an Angel Fund is one that raises
funds from Angel Investors, and invests such funds, as permitted under the AIF Regulations.
On the other hand, criteria have been set forth on who can be an Angel Investor. While SEBI
recognises individuals as Angel Investors in this category, SEBI states that it is guided by the
networth of the investor, indicating sufficiency of capital, as well as the investor’s prior
experience, indicative of clear understanding on such angel investments.
In the light of HNIs being largely the investor group in Angel Funds, both the criteria of
networth and experience have been made applicable to individuals.
Thus, in its fairly exhaustive definition of an Angel Investor, the Amendment seeks to reduce
risks arising from information asymmetry and inexperience by stating that an Angel Investor
is any person who proposes to invest in an Angel Fund and satisfies one of the following
conditions:
a) an individual investor who has net tangible assets of at least Rs. 2 crore excluding value
of his principal residence, and who:
(i) has early stage investment experience (i.e. experience in investing in start-ups), or
(ii) has experience as a serial entrepreneur (i.e. who has promoted or co- promoted more
than one startup venture), or
(iii) is a senior management professional with at least ten years of experience.
b) a body corporate with a net worth of at least Rs. 10 crores; or
c) an Alternative Investment Fund registered under the AIF Regulations or a registered
Venture Capital Fund.
The onus of conforming to (a) above is laid upon the sponsor of the Angel Fund.

Salient features of AIF Regulations as applicable to Angel Funds

Though Angel Funds have been positioned as a sub-category of a Venture Capital Fund under
Category I Alternative Investment Funds (“Category I- AIF”), their obligations slightly differ
from the other Category I- AIFs.
Corpus:
An Angel Fund must:
(a) have a corpus of at least Rs. 10 crore and
(b) accept an investment of not less than Rs. 25 lakh from an Angel Investor.
Both these thresholds are lesser than the respective figures prescribed for other Category – I
AIF, and further, an Angel Investor has been provided with a 3-year window within which it
can discharge its investment commitment to the fund. As an exception to the general rule, the
units issued by Angel Fund cannot be listed.

Investment in Angel Funds by Angel Investors

Angel Funds can invest such funds only in venture capital undertakings (which are defined in
the AIF Regulations to be unlisted companies other than in certain specified businesses). But,
going beyond this, SEBI has further narrowed down the investee-entities to ensure that only
genuine early-stage investing flows under this route.

It has hence prescribed certain restrictions on investment by Angel Funds.

I. Restrictions pertaining to the investee company:
The investee company must:
(a) complies with the criteria regarding the age of the venture capital
undertaking/startup issued by the Department of Industrial Policy and Promotion under
the Ministry of Commerce and Industry, Government of India ;
(b) have a turnover of less than Rs. 25 crores;
(c) not be promoted or sponsored by or related to an industrial group whose group turnover
exceeds Rs. 300 crores; and
(d) not be companies with family connection with any of the Angel Investors who are investing
in the company.

II. Restrictions on the investment

(a) The investment must not be less than Rs. 25 lakhs and not exceed Rs. 10 crores.
(b) The investment must be locked-in for a period of one year.
(c) Angel Funds must not invest in its associates.
(d) Angel Funds must not invest more than twenty-five per cent of the total investments under
all its schemes in one venture capital undertaking.
Any scheme floated by an Angel Fund can have only upto two hundred Angel Investors.

Schemes - The Angel Fund may launch schemes upon filing and approval of a scheme
memorandum at a shorter time frame of at least 10 working days prior to launch of the scheme
with SEBI.
Manager and Sponsor - The continuing interest of the manager or sponsor in an Angel Fund
is also lower than in other AIFs, being 2.5% of the corpus or Rs. 50 lakh, whichever is lesser,
and such interest should not be through the waiver of management fees.
Taking cognizance of the modus operandi of Angel Funds, where the investors make the
decisions relating to the investments, the manager of the Angel Fund is required to obtain an
undertaking from every Angel Investor proposing to make investment in a venture capital
undertaking, confirming his approval for such an investment, prior to making such an
investment.

Growing presence of angel investors in India

There are around 790 angel investors present in India, and about 6023 investors are interested
in providing funding for startups in India with an average valuation of US$ 2.8 million.
Average investment received from angels is grown from ₹10.63 million in 2009 to ₹46.76
million in 2015-16. Importantly, it signals the annual growth of 27 percent. As far as individual
angel investors are concerned, the average investment increased from ₹2.16 million in 2009 to
₹16.95 million in 2015, signalling an annual growth rate of 34 %.
Angel funding in Indian startups hit a five-year high in the March 2016, as venture capital firms
and previous angel investors pumped in cash to support the fresh batch of start-ups, according
to a report by InnoVen Capital. The report indicates angel funding in India in FY16 stood at
₹113.6 crore across 69 deals, a rise of about 62% in deal value and 47% in deal volume from
the previous financial year. In FY15, about ₹70 Crore invested across 47 deals.
Analysis of registered angel investor shows that 88% of angel investors are from Tier 1 cities
followed by Tier 2, Tier3 cities with 11% and 3% respectively. There is an apparent
concentration of investments in a few cities as one might expect: Bangalore, Mumbai, NCR,
Chennai, Pune, and Hyderabad. The other cities have hardly any significant number of
investments. Among the six-tier 1 cities, Delhi-NCR has the highest number of angel investors,
and it is followed by Mumbai & Bangalore respectively. The three cities together contribute to
88 percent of total angels in tier 1 cities.
While cities like Chennai, Hyderabad & Kolkata only account for 12 percent of total angel
investors in tier 1 cities of India.

Growth
India is an entrepreneurial nation, but its entrepreneurs have had to fight to create and grow
their business ventures. Accelerating entrepreneurship and business creation is essential for
large-scale unemployment gap. Moreover, entrepreneurship tends to be innovation-driven and
also help generate solutions to India’s multiple social issues including high-quality education,
low-cost health care, clean energy, and financial inclusion. Entrepreneurship-led growth is
more inclusive and usually does not involve a manipulation of natural resources.
In India, a large number of angel networks have come alive in the past decade. The amount of
funding received through angel deals shows growth in the investment activity of angels, with
a sharp rise of financing coinciding with the commencement of business by angel networks.
The number of angel deals grew from 18 in 2006 to 20 in 2007. In a span of 7 years, the number
of networks has increased 20 times, from 20 in 2007 to 400 in 2014. The growth of angel
funding in India has been slow. However, experts also believe that like Silicon Valley, angel
investors will discover their way to Indian startup, with the help of tools and right promotion.
The angel investment interest is growing in India, and it is creating a niche for investors. [4]
Indian Angel Network (IAN) has grown from 12 members in 2006 to 140 members in April
2006 and is growing exponentially. Anil Joshi, a member of Mumbai Angels, affirms that more
people have started joining organized channels and this has led to a greater deal flow. “Now,
we have access to ventures that are in the concept stage to three-year-old firms,” he says.
Members of IAN invested in 23 companies, including four overseas. A formal angel network
“Mumbai Angels” started with only two people; it grew to 20 in 2006 ad more than 100
members in 2016.
Correspondingly, Chennai Angels have fifteen members including top entrepreneurs like
Gopal Srinivasan, R Ramaraj, Suresh Kalpathi, HR Srinivasan and others.

Where to find angel investors in India

Angel Investors have to play a significant role in Indian startups. Indian Angel Network (IAN)
connects entrepreneurs with angel investors from India & abroad. It is a group of angels keen
to invest in early-stage start-ups with a new & innovative product. The members of the network
are chiefs in the Entrepreneurial Eco-System as they have had the high functional background
as CEOs or an experience of creating new and successful ventures.

InMobi Success Story

InMobi has grown to become the world's largest independent ad network serving over 100
Billion mobile ads
Seed round: Mumbai Angels group that collectively invested $500,000 in 2006
Series A: Kleiner Perkins (KPCB) and Sherpalo Ventures invested in 2008
Series B: $8 mil further investment by KPCB/Sherpalo.
Based on the last round, InMobi has generated 21X and counting Series C: Significant $200
million infusions from Japan’s Softbank – one of the largest investments in the mobile internet
space globally – making the total valuation gain of approximately 50X+ This is a good example
of backing a great team that is flexible and changes to market dynamics. InMobi (then mKhoj)
began in 2006 as a local search service that helped mobile users search for attractive shopping
deals in their vicinity. (m = mobile, and khoj in Hindi means “search”). When this did not take
off as expected, the founders listened well to market feedback, acted quickly and transitioned
the company into a “Mobile Advertising Marketplace”. Today, InMobi is truly global and has
claimed increasing market share against Google AdMob, to become the world’s largest
independent mobile ad network. India’s best known angel-funded tech story
Drawbacks
The Narendra Modi government met a long-standing demand of the Indian startup community,
announcing that angel investors will receive full exemption on their investments in startups.
But certain conditions apply, effectively meaning that very few young companies gain from
the move.
So far, an “angel tax” of over 30% was levied on funds invested by individuals in unlisted firms
at a share price higher than the fair market value. Indian angel investors paid this hefty tax,
even as venture capital firms and foreign investors were exempt from it.
Now, India’s income tax department has said that angel investors will be spared if they fulfill
a list of criteria, and the exemption will be retroactively implemented from April 11. These
conditions, however, don’t make things easy for investee and investor alike.
For instance, if an angel investor has to get income tax relief, the startup drawing the
investment must be approved by an inter-ministerial panel. This would include investors
providing their know-your-customer (KYC) documents, among other things, possibly
lengthening an already tedious process.
Moreover, a startup must be certified either by a government body or listed with an approved
incubator. It must also meet the government’s definition of a startup: incorporated in the last
seven years—10 years if in the biotechnology sector—with less than Rs25 crore ($3.7 million)
in turnover.
“There are a set of conditions to get certified by a body which says you’re a startup, which
itself takes time. It’s not like I apply today, and get a certification by the end of the day,” said
Anil Joshi, founder and managing partner at investment firm Unicorn India Ventures. “If that
(meeting the government’s startup definition) itself is going to take time and startups cannot
raise money until the time they’re certified, it’s only going to delay the process more.”

Conclusion
The Amendment is stated to address long pending demand to create a separate category for
Angel Funds, and in this it succeeds by delineating Angel Funds by its category of investors,
by their average corpus/investment size and intended beneficiaries. Angel funds have been
given lower thresholds, less procedures in floating a scheme and fee concessions.
However, Angel Funds are required to stay invested for atleast 1 year now instead of the
previous mandate of 3 years, in each of its investee-company under a mandatory lock-in. There
are also iron-cast restrictions on investing in associate companies or in companies with a family
connection, which even includes companies in which an angel director or his relative has a
board seat. These provisions though well-intentioned, may make the Angel Fund weigh in the
consequences of investing under this route.
In the light of the glaring gap between the entrepreneurial talent of Indians demonstrated across
the world, and lack of adequate early-stage funding channels within India, one is left to
conclude that the AIF regulations goes only so far in giving the long overdue recognition to
Angel Investors but this could also have been the platform to incentivise and nurture angel
investing as a mature investing model for the future.