With the introduction of the Co-Investment Vehicle ("CIV") scheme to Category I and Category II AIFs, the Indian regulatory environment has seen a massive stride towards the direction of the effective regulation of the private markets.
In the past, much of co-investment opportunities (where the investor in a fund is presented with the opportunity to co-invest with the fund in a particular deal) was facilitated by the Portfolio Management Services (PMS) route. Under the new framework, SEBI has placed a formalized co-investment framework in the form of AIF, hence providing enhanced transparency, regulation and simplicity of operations.
This is a significant change in case of Category II AIFs (in which case the fund managers are able to provide investors that are accredited to invest in a scheme with an unlisted portfolio company) and in this case, the fund manager is now able to offer the accredited investors the option to co-invest in a scheme of the AIF, which is now unlisted.
Key Features Of The Co‐investment (CIV) Scheme
Here are the main elements of the framework:
- In the case of co-investing in an unlisted investee company, a CIV scheme is established as a scheme of the AIF (the scheme of either category I or II) in which the AIF has, or proposes to invest, on its own.
- In the case of any such investee company, a single CIV scheme has to be launched (i.e. one CIV per underlying co-investment) and the fund manager has to submit a shelf Placement Memorandum (PPM) to SEBI of the CIV scheme including key terms, governance framework, regulatory disclosures etc.
- The scheme should have a separate bank account, separate Demat account, PAN, and the assets of the scheme should be separated with the main AIF scheme or other schemes of the fund.
- The CIV scheme can only be obtained by those accredited investors of the main AIF scheme.
- The amount of sum that an investor co-invests in a CIV scheme in a particular company is not allowed to surpass three times the amount that an investor contributes to the investment scheme of the main formalized co-investment framework in that particular company. This cap is subject to exemptions (e.g., the exemption of multilateral/bilateral development financial institutions, state industrial development corporations, sovereign wealth funds, government-controlled entities).
- The CIV scheme is not allowed to take loans or leverage.
- The CIV scheme cannot provide the indirect exposure that investors cannot have had directly, or investing in companies that the investor cannot invest directly, or where additional regulatory disclosure would be occasioned had the investor invested directly.
- The regulatory formalized co-investment framework is a little more lenient as opposed to the typical AIF schemes: e.g the diversification requirements, commitment of sponsor/manager, tenure minimum could be waived of the CIV scheme.
Why Does The Framework Matter?
As a fund manager, accredited investor and investee firm, the CIV structure has a number of benefits:
Flexibility to fund managers: This gives fund managers the ability to present some of their investors with the option to co-invest in high conviction transactions with the fund without the requirement of going through the general AIF structure or even the separate PMS vehicle.
Governance and transparency: The CIV framework requires a separate scheme, or ring-fenced accounts, a shelf PPM and formal disclosures, which provides a higher level of clarity and monitoring over the flow of co-investments.
Investor alignment: Accredited investors can access certain deal-level opportunities, which would possibly enhance returns and align with fund interests.
Streamlined company structure: Investee companies will be governed by a single AIF scheme and associated CIV investors as opposed to numerous discrete PMS investors, which may simplify the concerns of governance and the cap table.
Regulatory transparency and facilitation of business: The regulations are not complicated with the structure of co-investment, and by incorporating this activity into the AIF regime, SEBI contributes to further penetration of the Indian private markets.
Conclusion
The formalisation of co-investment through separate CIV schemes under Category II AIFs is an indication of the maturity of the regulation of the Indian private markets. It offers an organised open and transparent means of accredited investors collaborating with funds in unlisted investments, and governance and ring-fencing as well as investor protection. To fund managers, it is a useful feature that allows them to enhance their relationship with investors and customize access to high-conviction deals.
However, according to experts such as Punji Baazar, the key will be success through hard discipline performance, the selection of investors, the strong documentation (shelf PPMs), the strict adherence to the rules of the ring-fencing and structuring, and the clear alignment of interests. The CIV route can be a significant enabler in a landscape that is increasingly pursuing more capital and a wider range of investor involvement in the unlisted space.