Angel funds cannot exercise their pre-emptive rights to make additional investments and increase stakes in their existing portfolio companies if they have lost their startup status, according to the market regulator Securities and Exchange Board of India (SEBI).
“Extant AIF (Alternative Investment Funds) regulations do not provide for investment by Angel Funds in entities other than start-ups. Investments by Angel Funds, by exercising pre-emptive rights, in their existing portfolio investee companies which are no longer start-ups, would not be in line with AIF Regulations,” the regulator said.
The clarification was part of an informal guidance to startup investor FirstPort Capital Angel Fund concerning the provisions for angel funds under the AIF Regulations, 2012.
FirstPort in a letter in April last year had sought clarifications on certain operational issues faced as an angel fund.
The fund had asked if an investee startup company ceases to be eligible as a startup under the government’s criteria, can it exercise its pre-emptive right 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?
Pre-emptive rights give existing investors in a company the first right to buy additional shares in future funding rounds before the company offers them to external investors. Investors seek pre-emptive rights to maintain ownership stake, retain influence in a company and that they can continue backing high-potential startups.
Angel funds are required to invest in startups that meet specified conditions mentioned under Regulation 2(1)(wa) of the AIF regulations.
It defines startup as a private limited company or a limited liability partnership which fulfills the criteria for startup as specified by the Department of Promotion of Industry and Internal Trade (DPIIT) under the Ministry of Commerce and Industry.
As per DPIIT, startups should be operational for not over 10 years and incorporated as a private limited company or a registered partnership firm or a limited liability partnership. Moreover, the annual turnover should not exceed Rs 100 crore for any of the financial years since its incorporation.
SEBI also highlighted that the minimum amount invested by an angel fund in an eligible startup should be Rs 25 lakh. This requirement doesn’t apply in additional or follow-on investment by the fund in its existing portfolio startups.
