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Angel investments and regulation of angel funds – a primer

The earliest source of funding for a startup is, naturally, promoters’ / founders’ own money, their friends and family. The next stage is raising investment from angel investors. Angel investors are typically sophisticated investors and they are known to understand the relevant industry-sector extremely well (many of them may have formerly been successful entrepreneurs themselves). After angels, startups may typically look at raising capital from professional venture capitalists, which are typically financial investors. Conceptually, angels typically invest their own money, whereas venture capitalists typically have a ‘fund’, which has contributions from various investors. The venture capital firm invests a portion of this pooled money into the startup.

In 2013, SEBI instituted a mechanism to regulate angel investors (explained below). The policy reason behind this is that since startup investments are extremely risky, SEBI wants to ensure that they are made only by investors who are sophisticated and aware of the consequences of their investment.

Depending on the nature of the investment, the following regulations may be attracted in the event of angel investment:
  • Where an individual invests SEBI (Investment Advisers) Regulations, 2013 – These will govern an investment when an investment has been made on the basis of investment advice. Typically, investment advice is considered to be provided when consideration (that is, monetary payment) has flowed from the person who has made the investment to another person. This can also be in the form of a ‘carry’ (or carried interest), that is, a performance fee linked to the appreciation in investment). In the absence of consideration, it is very difficult to establish the existence of ‘advice’ at a practical level – it may as well be a casual or non-serious opinion.
  • Where funds are pooled together and invested, the SEBI (Alternative Investment Funds) Regulations, 2012 will apply.
It is important to be able to recognize when funds are being pooled, or when investment advice is said to have been provided. If an individual angel invests his own money, none of the above regulatory frameworks will be attracted. This is the case for most angel investments. Often, investors ‘co-invest’, that is, Investor A may piggy-back on the decision of Investor B and invest in the company. We are not referring to a case of joint investment - Investor B is investing his own money, and of his own free will has decided to make an investment in the same company as investor A (the fact that Investor A has decided to invest may have had a favourable bearing on the decision of Investor B to invest). However, note that Investor A has not advised him to make this investment. Several angel investments in real life are of this nature and hence do not come within the purview of any of the above regulations.

How are angel networks (e.g. Indian Angel Network or Mumbai Angels) regulated or structured?
Many angel investor networks are merely a group of angel investors coming together so that they can have access to startups and investment opportunities. They may not be pooling in money, but merely invest in their individual capacity. However, in these cases as well, they may create a legal entity to manage the administrative processes of the group – the entity can charge a periodic contribution from the members so that it is able to meet its administrative expenses. For example, the Mumbai Angels are organized as a non-profit company, that is, a Section 25 company (under the old Companies Act) / Section 8 company (under the new Companies Act).

Let’s hear from Suhas Baliga, Principal at Impact Law Ventures, who has been regularly advising startups, incubators and early stage venture capitalists with investment documentation (he has also advised the government and several clients on public private partnerships and power projects worked at Trilegal and Luthra on government):


What is the regulatory framework when the investment is pooled?

When investment is pooled, the investment transaction will be governed by the SEBI (Alternative Investment Funds) Regulations, 2012 (“AIF Regulations”). Under the regulations, angel funds are classified as Category I-Venture Capital Funds. The AIF regulations govern the size of the fund, qualification of an investor who makes a contribution to the fund, the size of the investment into the company and the companies into which such investments can be made.
Detailed provisions may be accessed on by referring to the regulations here, but a quick summary is provided below:

Size of the fund and investment amount from investors
  • The total fund corpus must be at least INR 10 crores.
  • Minimum investor contribution should be at least INR 25 lakhs, which may be accepted over a period of maximum 3 years.
  • The sponsor or manager of the fund must have a continuous personal investment of 2.5% of the corpus or INR 50 lakhs, whichever is lesser.
Sources of contribution for angel funds

There are restrictions on what kinds of individuals or corporate entities can contribute to angel funds – the policy once again being to keep away unsophisticated investors from this segment as these are high-risk investments. Angel funds can only raise funds from ‘angel investors’, defined as:
  • Individuals who have early stage investment experience / be serial entrepreneurs, or senior management professionals with 10 years of experience. They will be required to have INR 2 crore of assets, or
  • Corporate entities which have a net-worth of at least INR 10 crores or which are already registered with SEBI as alternate investment funds or venture capital funds.
Note that an angel fund cannot have more than 49 investors.

Which companies can angel funds invest in?

Angel funds can only invest in unlisted companies which are less than 3 years old and have a turnover of less than INR 25 crores. Further, the company must not have a family connection with investors who are proposing to invest through the fund, and most not be promoted or connected with an industrial group whose turnover is greater than INR 300 crores. For example, a small company promoted by Reliance Industries Limited will not be eligible to receive investment from angel funds. This is done to ensure that angels are genuinely investing in an early stage startup.

What is the minimum size of investment and other limitations on investments by angel funds?
  • Investment size can range between INR 50 lakhs to INR 5 crores. The investment should be held for a period of at least 3 years (this is the lock-in period before which the angel fund cannot exit).
  • An angel fund cannot deploy more than 25 per cent of the total investments under all its schemes in one company.

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