To boost startup financing, government offers incentives to VC, PE funds
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The fund of funds for startups (FFS) was introduced in 2016, for contribution to various alternative investment funds (AIFs) registered with the capital market regulator Sebi. The FFS, run by the state-controlled Small Industries Development Bank of India (SIDBI) has invested more than Rs 9400 crore in 86 AIFs (the regulatory term for PE and VC funds).
SIDBI is the country’s largest limited partner (LP), investors contributing to the capital shored up by VC and PE funds.
In a letter dated 29 April 2022, SIDBI told AIFs that it would allow “accelerated drawdowns” of the money committed by the FFS while fund managers achieving internal rate of returns higher than the hurdle rate — the minimum return a fund has to clock in before profits can be shared between investors and fund manager — can enjoy a bigger slice of profit.
“These are concrete steps to ensure that investments by the FFS in eligible Indian AIFs can be on better commercial terms when it comes to management fee, carried interest for the qualifying and performing fund managers, whilst also extending more flexibility to fund managers in their day to day operations. SIDBI managed FFS has been one of the most important domestic institutional investors in Indian VC Funds and the liberalisation of many existing onerous terms in the investment agreements will help in aligning such terms with those prevalent globally,” said Tejesh Chitlangi, Senior Partner, IC Universal Legal.
Since AIFs often take a long time to mobilise capital from other investors, a quicker drawn down of the money committed by the FFS will enable that the deal making capability of AIFs is not hampered.
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The `carry’ or the profit sharing (once the fund’s IRR crosses the hurdle rate) is typically in the ratio of 80:20, with 20% going to the manager. The FFS is now ready to pass on 25% of the incremental returns (over and above the new IRR) if the IRR exceeds 25%. The share of carry would be 30% (of the incremental return) if the fund achieves an IRR of above 30%.
The FFS, as per the SIDBI letter the funds, will consider paying a higher management fee after taking an overall view on the total expenses, and if a fund is women-led, focuses on women-led startups, focuses on priority areas, agro-rural sector, financial inclusion, and is committed to invest in tie-2 and 3 centres.
The FFS is also open to investing in funds above Rs 1000 crore corpus as long as a fund’s investment manager is a domestic entity, the key persons or managers had managed funds to which SIDBI had made commitments in the past, and exposure is capped at the same level as applicable for a fund with corpus of Rs 1000 crore.
“Accelerated drawdown would help funds still in fund-raising mode, to enhance deployment. The option to segregate IRR based carry is very well calibrated. The design of the options may prompt sophisticated fund managers that have insights into the expected return profiles to deliberately trade-off their preferences. The Policy increases the overall transparency and strengthens support to the industry, specifically first-time fund managers,” said Richie Sancheti, Founder, Richie Sancheti Associates.
SIDBI would be more lenient to funds for inadvertent errors. Till now, the financial institution would cancel its commitment and ask a fund to return its contribution if a fund manager gives misleading information or violates the terms and conditions and fails to address the concerns within a month. According to the letter, “At the time of considering invocation of the clause or triggering its consequences, the following process may be followed: breaches of technical/ inadvertent / compoundable nature, i.e, where the issues can be suitably resolved between the fund / IM and SIDBI based on mutual agreement need not be escalated and may be closed at the level of SIDBI.”
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