The Securities and Exchange Board of India has provided a crucial lifeline to venture capital funds (VCFs) by allowing them to transition from the SEBI (Venture Capital Fund) Regulations 1996 (VCF Regulations) to the SEBI (Alternative Investment Fund) Regulations, 2012 (AIF Regulations). During its board meeting on April 30, 2024, SEBI approved a proposal to provide an option to VCFs which are nearing the end of their tenure yet unable to fully liquidate their portfolio to migrate into the AIF Regulations. This move allows these VCFs to manage unliquidated investments as permitted under the AIF framework. Significant changes to the AIF Regulations have been implemented through a new Circular, altering the liquidation framework for the treatment of unliquidated investments at the end of an AIF’s term. Notably, the circular eliminates the concept of launching ‘liquidation schemes’ for rolling over of unliquidated investments. AIFs must now dispose of their assets within one year from the term’s expiry, i.e., within the “liquidation period.” After this liquidation period, the AIF may either enter a “dissolution period" to liquidate the remaining investments or distribute the assets in specie to the investors, with at least 75% investor consent by value. To learn more about the Circular please read our article titled “Dissolution Period for AIFs: Lifeline for Funds with an End-of-life Crisis”, available here.
Allowing VCFs to now migrate to the AIF construct to deal with unliquidated investment as available to AIFs in the manner described above is timely, considering the number of VCFs in India nearing the end of their terms. SEBI has historically penalised funds for operating beyond their prescribed term. Recently, SEBI passed an adjudication order on 21 February 2024 against India Growth Fund, a scheme of Kotak SEAF India Fund, reaffirming its resolve in deterring extension of terms of VCFs in India. The first such order was passed by SEBI in 2019 against Cinema Capital Venture Fund which was subsequently affirmed by the Securities Appellate Tribunal in 2021.
In this instance, due to several unresolved litigations in the portfolio companies, the Investment Manager decided to extend the term of the Fund beyond its tenure as the alternative would not have been a desirable outcome for the investors. However, SEBI maintained its stance on winding up of VCFs, and held that by failing to wind up the Fund upon completion of its tenure as disclosed in the original private placement memorandum and by extending the term beyond the PPM on three occasions, the Fund, the Investment Manager and the Trustee of the Fund had violated of Regulation 23(1)(a) of the VCF Regulations read with Regulation 39 of the AIF Regulations.
While prolonged legal proceedings, outstanding liabilities and other macroeconomic issues often make it commercially unviable for fund managers to exit investments, forcing a fund manager to undertake a distress sale or make distribution in kind of unliquidated investments at the end of the prescribed term without assessment of the assets at hand, is likely to be counter intuitive to investor protection.
Thankfully, SEBI has taken cognizance of the representations from surviving VCFs regarding the difficulties faced by VCFs to fully liquidate their investments. In response to this, in its latest board meeting on April 30, 2024, SEBI has approved the proposal to provide an option to VCFs nearing the end of their tenure yet unable to fully liquidate their portfolio to migrate into the AIF Regulations. This is a fresh, cost-effective solution to a long-standing conundrum, which has been made available to VCFs after much lobbying from stakeholders.
This decision addresses the urgent need to protect investments in several VCFs operating in the country. Although the details are pending, this move is expected to mitigate the growing regulatory penalties for VCF term extension and preserve investor value where possible.
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