Alternative Investment Funds (AIFs) :Venture Capital & Hedge Funds Dr. Manu Datta Meaning of AIF • Alternate to traditional form of Investment • Privately pooled investment funds • Can be in the form of Company, trust, LLP etc. • Not governed by any SEBI governing fund management • Not coming under the direct regulation of any other sectoral regulators . ( Section 2(1) (b) of SEBI (Alternative Investment Funds) Regulations , 2012 SEBI Alternative Fund Regulations 2012 • Registration of AIFs • Investment in AIFs : Minimum corpus (20cr.) • Restriction on borrowing /leverage. • Annual reports to investors Venture Capital Funds : Meaning • Venture Capital may be defined as a fund in the form of Company or trust which exclusively trades in financing a business at various stages • Venture Capital is a High Risk High Gain business especially when investment is made at initial stages • Venture Capital Funds provide funds when business is not listed in Stock exchange and therefore cannot raise finances from public • Venture Capital may be in the form of equity or Soft loan instruments • Venture Capital funds are regulated by SEBI Regulations • Venture Capital Funds do not want to retain investment • AIF Regulations 2012 have replaced SEBI (Venture Capital Regulations) 1996 • It is in the form of equity capital. • Investment made only in high risk but high growth potential projects. • There is continuous involvement in business after making an investment. • Investment is usually made in small & medium scale enterprises. Stages of Financing • Initial Stage Seed Capital Financing (Research and Development laboratory stage) Start UP Capital (Commercial state, product launching ) Second Round Financing ( further financing for marketing etc) • Later Stage Expansion Finance (acquisition, adding production capacity) Replacement Finance (Relacing existing equity capital) Turn Around (For revival) Exit Route • i) Initial Public Offering: When the shares of the investee company are listed on the stock exchange(s) and are quoted at a premium, the venture capitalist offers his holdings for public sale through public issue. • ii) Buy back of Shares by the Promoters: In terms of the agreement entered into with the investee company, promoters of the company are given the first opportunity to buy back the shares held by the venture capitalist, at the prevailing market price. In case they refuse to do so, other alternatives are resorted to by the venture capitalist. • iii) Sale of Enterprise to another Company: Venture capitalist can recover his investments in the investee company by selling the holdings to outsider who is interested in buying the entire enterprise from the entrepreneur. • iv) Sell Venture Capitalist to New A venture capitalist can sell his equity holdings in the enterprise to a new venture capital company, who might be interested in buying the ownership portion of the venture capital. Such sale may be distress sale by the venture capitalist to realise the investments and exit from the enterprise. Alternatively, such sale may be for inducting a willing venture capitalist who wishes to take the existing liability in the company to provide second round of funding. • vi) Liquidation of the Investee Company: If the investee company does not become profitable and successful and incurs losses, the venture capitalist resorts to recover his investment by negotiation or settlement with the entrepreneur. Failing which the recovery is resorted to by means of winding up of the enterprise through the court Foreign Venture Capital Investor • A foreign venture capital investor proposing to carry on venture capital activity in India may register with the Securities and Exchange Board of India (“SEBI”), subject to fulfilling the eligibility criteria and other requirements contained in the SEBI Foreign Venture Capital Investor Regulations. The SEBI Foreign Venture Capital Investor Regulations prescribe the following investment guidelines, which can impact overall financing plans of foreign venture capital funds. a) The foreign venture capital investor must disclose its investment strategy and life cycle to SEBI, and it must achieve the investment conditions by the end of its life cycle. b) At least 66.67 per cent of the investible funds must be invested in unlisted equity shares or equity linked instruments. c) Not more than 33.33 per cent of the investible funds may be invested by way of: Subscription to initial public offer of a venture capital undertaking, whose shares are proposed to be listed. Advantages • Easier for promoter than listing • Protect investor from inefficient management • Experienced leadership and advice • Contribution to growth , reducing time lag between different stages of production Disadvantages • Reduction in stake of founders • Pressure to grow rapidly • Under performers and loose their business • Scarce and difficult to obtain Hedge Funds Dr. Manu Datta Meaning • A hedge fund typically is an investment product that is formed by pooling investments from multiple investors. They are privately pooled investment funds that earn high returns by investing in non-traditional assets. In India, the categorization is under as Alternative Investment Funds (AIF). Strategies • Taking advantage of corporate actions such as acquisitions • Arbitrage • Taking advantage of global market trends Characteristics • Minimum investment: • The minimum investment is INR 1 crore. Only high net worth individuals (HNIs), banks, insurance companies, and pension funds can invest in hedge funds. SEBI, like mutual fund investors, doesn’t protect hedge fund investors. • Fee Structures: • The expense ratio for hedge funds can be around 2%. The managers also charge on the profits earned. The performance fee is approximately 20%. The two-twenty rule of fee structures is followed globally but not restricted to these numbers. • Portfolio: • Hedge funds have a diversified portfolio ranging from equities, bonds to derivatives, private equity fund, currencies, and venture capital. It can invest in non-traditional asset classes and hence have a diversified portfolio. • Liquidity: • Hedge funds have lock-in periods and are not highly liquid. The withdrawals can be monthly or quarterly. Hence they aren’t highly liquid in comparison to other investment avenues. Mutual funds: • Don't take share from the profit • Are available to the general public • Charge a management fee (normally 1–2%) • Generally don’t make high-risk investments • Tend to perform worse than hedge funds Hedge funds: • Take ~20% performance fee from the profit • Are available only to high-net-worth and • Charge management fee (normally 2%) plus performance fee (normally 10–30%) • Generally make high-risk investments • Tend to perform better than mutual funds in terms of return Continued • Risks: • They are prone to huge losses. Hedge funds, though manage risk, are considered highrisk investments due to their aggressive nature. There is also an exposure to fund manager risks. • Taxation: • The taxation is heavy on Hedge funds in India. They come under the Category III of AIF, the tax rate is 42.74% on annual earnings over INR 5 crores. • Absolute return products: • There are no benchmarks for hedge funds to know their relative performance. Their performance is independent and measured in absolute terms. • Hedge fund manager: • There can be multiple managers, and sometimes the manager might invest their own money in the fund. It ensures safety for investors. The fund can be prone to the manager’s risk as well. Due to the inefficiency of the manager, the fund’s performance can suffer. • It was introduced in 2012 by Securities and Exchange Board of India Advantages • Diversification • Managerial Expertise • Personalized Portfolio Disadvantages • impossible for an average investor to invest. • Liquidity Risk: These are long term investment instruments and have lock-in periods. Therefore, these are not highly liquid investments. • Less Regulation : Not strictly regulated by SEBI
