Angel fund cannot raise exposure in investee company that is no longer a startup: SEBI's guidance note

Under this section, a startup means a private limited company or a limited liability partnership (LLP) which fulfills the criteria for startups as specified by the Department of Promotion of Industry and Internal Trade (DPIIT), Ministry of Commerce and Industry, via notification no. G.S.R. 127(E) dated February 19, 2019 or such other policy of the Central Government issued in this regard from time to time.

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FirstPort Capital had asked the regulator whether an angel fund, which had invested in a company that was eligible to qualify as a startup initially and later became non-eligible, could still exercise the pre-emptive rights which it enjoyed at the time of the original investment.

To this, Sebi's guidance note replied in the negative.

The fund asked, "Angel Fund had made an investment in a startup, meeting eligibility criteria as per DPIIT notification (G.S.R 34 (E) dated January 16, 2019). Subsequent to this investment, the startup (“Investee Company”) over a period of time ceases to be eligible as a startup under the eligibility criteria as per DPIIT notification.

"In such an event, can the fund exercise its pre-emptive right/rights issue/renounced rights issue of shares against convertible securities as per shareholders agreement by subscribing to the offered capital in terms of the definitive agreements executed at the time of the original investment?"

The guidance note said: "Extant AIF Regulations do not provide for investment by angel funds in entities other than startups. Investments by angel funds, by exercising pre-emptive rights, in their existing portfolio investee companies which are no longer startups, would not be in line with AIF Regulations."

Trust as angel investor

The fund had also raised other queries in the same application, including whether a trust can be an angel investor.

To this, the guidance note said that a trust cannot be an angel investor in an angel fund, unless it is registered as an AIF or a venture capital (VC) fund.

The guidance note cited the definition of an angel investor under Regulation 1 (A) of the AIF Regulations. Under that, an angel investor could also be a body corporate with a net worth of at least Rs 10 crore.

To expand on the definition of body corporate, the note pointed to Section 2 (11) of the Companies Act which says ―corporation includes a company incorporated outside India, but does not include—
(i) a co-operative society registered under any law relating to co operative societies; and
(ii) any other body corporate (not being a company as defined in this Act), which the Central Government may, by notification, specify in this behalf; Thus, relevant provisions of the Companies Act, 2013, may be referred for any clarification/interpretation on which entities qualify as ‘body corporates’.”

Thus, the guidance note said, "in terms of Regulation 19A(2)(b) of the AIF Regulations a trust cannot be an angel investor in an angel fund unless it is registered as an AIF under the AIF Regulations or a Venture Capital Fund under SEBI (Venture Capital Funds) Regulations, 1996."

Informal guidance from the regulator comes with a note which says that the position clarified is "specific and and based on the information / representation provided" in the applicant's letter. It added, "Different facts or conditions might entail a different interpretation. This letter does not express decision of the Board on the queries referred in your letter."