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Amended SEBI – AIF Regulations : Impact on Angel Funds and Start-ups

Angel investor India

Background

The introduction of section 56(2)(viib) in the year 2012, with effect from 1st of April 2013 caused much trepidation in the minds of investors and entrepreneurs alike. Introduced ostensibly to reduce money laundering  the provision stated that consideration received by a private company or unlisted public company for shares, in excess of the Fair Market Value (“FMV”) of such shares will be considered incomes in the hands of the company and chargeable to tax as “income from other sources”.  In simple terms, where the monies received by an issuing company in lieu of shares in the company exceed the fair value of such shares, the excess money received by the company shall be subject to tax in its hands at normal tax rates applicable to such company.

To explain this by way of an illustration, lets assume an early stage start-up, company A issues shares with  face value of Rs 10 to investor firm “B” who see plenty of promise in the company and therefore accord its shares such high value, by buying such shares at Rs 500 per share. Therefore “A” receives a total of Rs 500 for the sale of (say) 1 share in the company.  Any consideration received by the company in excess of the fair value of its shares shall be taxable in its hands.  Assuming the fair value of the shares of A is Rs 20 ( using Rule 11U and 11A), Rs 480 [ Being Consideration less fair value (Rs 500- Rs 20)] shall be taxable in the hands of A as income from other sources.

The government, in the interests of investors and investees, provided exemption under this section to cases where the investment was received by the company from a venture capital company or venture capital fund.

For the purposes of this regulation venture capital companies are defined by section 10(23FB) of the income tax act as a company which has:

A)  Been granted a certificate of registration, before the 21st day of May, 2012, as a Venture Capital Fund and is regulated under the Securities and Exchange Board of India (Venture Capital Funds) Regulations, 1996 made under the Securities and Exchange Board of India Act, 1992; or

(B)  Has been granted a certificate of registration as Venture Capital Fund as a sub-category of Category I Alternative Investment Fund and is regulated under the Securities and Exchange Board of India (Alternative Investment Funds) Regulations, 2012  and which fulfils the following conditions, namely:—

    1. it is not listed on a recognised stock exchange;
    2. it has invested not less than two-thirds of its investible funds in unlisted equity shares or equity linked instruments of venture capital undertaking; and
    3. it has not invested in any venture capital undertaking in which its director or a substantial shareholder (being a beneficial owner of equity shares exceeding ten per cent of its equity share capital) holds, either individually or collectively, equity shares in excess of fifteen per cent of the paid-up equity share capital of such venture capital undertaking;

Similarly a venture capital fund means a fund—

(A)   operating under a trust deed registered under the provisions of the Registration Act, 1908 (16 of 1908), which—

I.            has been granted a certificate of registration, before the 21st day of May, 2012, as a Venture Capital Fund and is regulated under the Venture Capital Funds Regulations; or

II.            has been granted a certificate of registration as Venture Capital Fund as a sub-category of Category I Alternative Investment Fund under the Alternative Investment Funds Regulations and which fulfils the following conditions, namely:—

  1. it has invested not less than two-thirds of its investible funds in unlisted equity shares or equity linked instruments of venture capital undertaking;
  2. it has not invested in any venture capital undertaking in which its trustee or the settler holds, either individually or collectively, equity shares in excess of fifteen per cent of the paid-up equity share capital of such venture capital undertaking; and
  3. the units, if any, issued by it are not listed in any recognised stock exchange; or

(B)  operating as a venture capital scheme made by the Unit Trust of India established under the Unit Trust of India Act, 1963

Despite the relaxations to Venture capital funds and Venture capital companies, early stage start-ups were still affected as Angel investors, the most prolific investors in such category of companies, were not eligible to register as Category 1 AIF investors with SEBI.

The step forward

In a board meeting on the 25th of June 2013, the Securities and Exchange Board of India (SEBI) made amendments to the Securities and Exchange Board of India (Alternative Investment Funds) Regulations, 2012 giving effect to the announcements as made by the honourable finance minister in his budget speech given earlier this year.

Under the amended rules, Angel investor pools can be registered under a separate sub- category under category 1 Venture capital funds, being “Angel funds”. The terms and conditions as stipulated by the board for such registration are :

  • Individual angel investors would be required to possess early stage investment experience/ experience as a serial entrepreneur or  be a senior management professional with at least 10 years of experience.
  • Such investors shall be required to have net tangible assets of at least Rs. 2 crore. Corporate angel investors shall be required to have Rs. 10 crore net worth or be a registered AIF/VCF.
  • Angel Funds, to be eligible for registration,  shall need to have a corpus of a minimum of Rs.10 crore (as against Rs. 20 crore for other AIFs)
  • Investors in the fund shall be required to invest an amount not less than Rs. 25 lakh (which may be accepted over a period of maximum 3 years) as against Rs. 1 crore for other AIFs
  • Individuals to be appointed as sponsor/managers in the fund should continue to hold not less than 2.5% of the corpus or Rs. 50 lakh, whichever is lesser
  • Such registered angel funds can invest only in companies which:

 

    1. are incorporated in India and are not more than 3 years old; and
    2. Have a turnover not exceeding Rs.25 crore
    3. are unlisted, and
    4. are not promoted, sponsored or related to an Industrial Group whose group turnover is in excess of Rs.300 crore, and
    5. has no family connection with the investors proposing to invest in the company.
    6. Further, investment in an investee company by an angel fund shall be not less than Rs.50 lakh and not more than Rs.5 crore and shall be required to be held for a period of at least 3 years.

Our Take

This is most certainly a welcome step and shall be cheered by the industry. The experience requirement however, may act to keep out many otherwise eligible investors who may have the wherewithal and the  ability to invest. In the case of  organized funds, as opposed to individuals angel investors, the fund is most likely to be managed by a professional fund manager. In this light, to preclude investors on lack of experience seems a bit harsh. The minimum corpus and net asset requirements for the fund and investors, respectively are aimed at ensuring diversification and safety in terms of the investments made by the fund.

The inclusion of Angel funds as a subcategory in Category I AIF further ensures that tax pass through status is available to the fund. This would imply that any gains from exits shall be taxable not in the hands of the fund but rather in the hands of the individual/corporate investors.

 

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