Sebi's opt-out clause in new rules may hit angel funds

Operational issues, lack of clarity on implementation could play spoilsport

The Securities and Exchange Board of India (Sebi)’s decision to allow investors in angel funds more power over their investments may leave the funds grappling with implementation issues.

Now, fund managers have to secure the approval of angel investors on an individual basis before making an investment, an ‘opt out’ clause introduced as part of a gazette notification implementing the new rules for angel funds from Monday. “The manager of the angel fund shall obtain an undertaking from every angel investor proposing to make an investment in a venture capital undertaking, confirming his approval for such an investment, prior to making such an investment,” the notification said.

Every scheme of an angel fund can have up to 49 investors.

Bhavin Shah, partner, KPMG, said the move would create hurdles in calculating the internal rate of return (a measure of profitability or returns). “This will add to the administrative burden for fund managers and create operational challenges,” he said.

With more investors, the challenges would be greater. Each investor may have a different internal rate of return, depending on the investment profile. Also, there would be no common net asset value and multiple calculations would be required to compute the performance incentive for the fund manager. This might mean different schemes would be needed for different investors or different companies

Darshan Upadhyay, partner at Economic Laws Practice, said, “It appears this regulation will require an approval from all investors for making an investment. This may create operational hurdles. For example, what if one investor refuses? Can the manager drawdown the commitments from others who have approved and go ahead with the investment?” he asked.

The notification didn’t mention the process to be followed if a section of the investors turned down an investment idea.

Currently, investor approval was required at times, under special or unusual circumstances such as when an investment manager wished to allocate money outside his mandate, Upadhyay said.

However, some feel the new regulations seek to align the practices of individual angel investors with those of pooled funds. Groups of angel investors working together take individual decisions on which companies they want to back.

Padmaja Ruparel, president of the Indian Angel Network, said the move was a positive one that could be implemented through separate silos. “It may be the case that in a single fund, there would be a scheme for every investment which, in turn, would have a unique set of investors,” she said.

Angel funds are a subset of venture capital funds that typically comprise wealthy people investing their own money. Venture capital funds have people who invest money on behalf of several institutions, under a pooled fund structure.

The move for greater control was a positive step from an investor’s perspective, considering it was a high-risk investment, said Shah.

CLAUSE FOR CONCERN

* Sebi says angel funds need approval from each investor for making an investment

* Currently, investor approval is sought only if fund manager wishes to make investment outside his mandate

* Move is likely to create difficulties in calculating returns or asset value

* Some feel the move seeks to align practices of individual angel investors with those of pooled funds