Private equity (PE) and venture capital (VC) funds holding money for 5 or fewer investors have drawn the attention of the capital market regulator.

Do such funds act as vehicles of family offices and promoters? Do managers of such funds come under the influence of a handful of wealthy investors? Is the regulatory interest a precursor to a

A broad-based rule requiring a larger number of investors?

While the intent of the regulator is unclear, the Securities & Exchange Board of India (Sebi) has in an email on September 12 — A week after it asked PE and VC funds about their valuation practices — sought various information on funds formed with a small club of investors, two senior industry persons told

These funds have to give details of investors in a scheme: name of the investors; whether it’s an individual, company, limited liability partnership, or trust; the country of the investor; the amount it has committed and the quantum of fund raised.

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They have to also submit the name of the investee company, its country of origin, nature of business, and the instrument issued (equity, debt, convertible etc) to raise money. The details have to be provided for every scheme of an alternative investment fund (AIF) – the regulatory term for PE, VC and angel funds. Besides, the name of a contact person in every fund along with the mobile number have to be shared with Sebi.

Usually, funds with less than five contributors (excluding the sponsor and the manager) are captive in nature. We have seen many family offices, large investors, and corporates using AIFs to hold stakes in companies. Probably, they don’t want to reveal their identities. Investee companies too prefer the name of a single AIF in the cap table rather than five different investors in the fund… But we don’t really know why Sebi has asked for the information. Maybe, it wants to know more about such captive funds,” said a person with a fund trustee.

According to Tejesh Chitlangi, senior partner at IC Universal Legal, while AIFs, unlike mutual funds, do not have any broad-basing requirement, SEBI may be examining the feasibility of introducing some form of investor broad-basing for AIFs. “But any such rule, if under consideration, should not be as stringent as the 20/25 requirement prescribed for mutual funds because mutual funds raise retail money unlike AIFs which approach big-ticket investors through privately placed AIFs,” said Chitlangi

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MFs have to follow a 20/25 rule under which every scheme needs to have a minimum 20 investors with no investor holding 25% units in the scheme. An AIF, however, can even have a single investor though not more than a quarter of the fund corpus can be invested in a single entity.

Also, it may be perceived that a small group of investors end up influencing the fund manager and the portfolio construction. “But such a concern may not be well placed as funds need to make a regulatory disclosure in case investors have any role in approving investment decisions, including through annual audit exercises. A fund of one investor is not unusual as India has typically been accessed through master-feeder type structures, where in addition to the feeder, the master fund may have only sponsor group participation,” said Richie Sancheti, founder partner at the law firm Richie Sancheti Associates (RSA).

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

Sebi is asking for data for certain analyses. This will be used to take decisions on the policy front,” said a person close to the development.

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Sebi has been gathering a wide range of data on AIFs, probably given the rise in their importance as investment vehicles. Often, such exercise can precede regulatory changes. On September 6, the regulator had asked AIFs to disclose their valuation methodologies – a query that assumes significance as most funds are close-ended vehicles investing in unlisted securities of startups.

A week before that Sebi asked funds to spell out whether the sponsor and manager of the funds were owned and controlled by persons who are foreign residents. Even in the latest communication (dated September 12), funds with five or lesser investors have been told to declare whether their sponsors are controlled by non-residents. A sponsor contributes Rs 5 crore or 2.5% of the fund whichever is lower.