AIFs seek co-investment vehicles to allow bespoke deals for key investors

Global market for such deals has been on the rise since at least 2012; one fund exploring opportunities in India.

Sophisticated investment funds for the rich are looking for ways by which some of their investors could pickup additional stake in select investee companies through specially structured deals, over and above the stake taken by the funds themselves.

At least one fund has been exploring such transactions and there has also been an effort to get regulatory clarity on this, said people familiar with the matter.

Globally, investors in a private equity fund are allowed to buy additional stake in the scheme’s investee companies on an individual basis. 

This co-investment is done through separate vehicles (or sleeves) within the fund, which is made up of a small subset of investors. Around 60 per cent of private equity investors were planning co-investment opportunities in 2020, compared with 24 per cent who were making such investments in 2012, according an October 2020 JPMorgan Chase note titled ‘Private Equity Co-investing’.

“In fact, Cambridge Associates estimates global private equity co-investment capital to be Rs $60 billion ...(or 20 per cent)...of the overall...(private equity market)... co-investments can be a source of high returns at reduced costs, but the inherent risks and implementation considerations should be carefully weighed in order for investors to realise the full benefit of an allocation to co-investments within their private equity portfolios,” it added.

Tushar Sachade, principal, Price WaterHouse, said global jurisdictions allow alternative investment funds (AIFs) to set up co-investment either in the form of separate SPVs (special purpose vehicles) or by structuring it within the fund. The SPV itself can be created in India through a limited liability partnership or other structures. However, there is no regulatory clarity on the implication of creating such vehicles.

“There is a grey area on whether these vehicles have to comply with the AIF regulations,” he said.

As these SPVs will most likely hold a single investment, it will be difficult for them to comply with Sebi’s AIF regulations, which requires such vehicles to invest in more than one company. Category I and II AIFs cannot invest more than 25 per cent of their funds in one company. The limit is 10 per cent for category III AIFs.

The authorities could consider permitting these co-investment vehicles under some regulatory supervision or allow creation of separate unit classes within the existing AIF framework, subject to some safeguards, he said.

The International Financial Services Centres Authority (IFSCA) allowed co-investment in December for AIFs domiciled in the Gujarat International Finance Tec-City (GIFT city). The IFSC has been set up to provide an alternative to global jurisdictions for funds investing in India.

“An AIF in IFSC is permitted to... co-invest in a portfolio company through a segregated portfolio by issuing a separate class of units,” according to the December 2020 circular. It added that investors must be treated equally whether they invest through co-investment or through the fund.

“The investments by such segregated portfolios shall, in no circumstance, be on terms more favourable than those offered to the common portfolio of the AIF,” it said.