New Delhi, June 19 -- The Securities and Exchange Board of India has overhauled several rules governing alternative investment funds (AIFs) that will allow limited partners (LPs) to participate directly as co-investors in private market deals and make it easier for private equity and venture capital to monetise their investments in companies at the time of their initial public offerings.

The capital markets regulator allowed Category I and Category II AIFs to offer a co-investment scheme to their LPs with a view to supporting capital formation in unlisted companies, it said in a statement after a board meeting on Wednesday. Category I includes venture capital funds and infrastructure funds while Category II includes PE funds.

The decision came more than a month after SEBI, in a consultation paper, proposed to allow LPs to make co-investments directly through AIFs instead of through separate portfolio management services.

AIFs registered with SEBI are currently allowed to bring LPs as co-investors via the PMS route. For that, AIF managers have to separately register under PMS rules. This adds to the cost structure and creates other hurdles. This tends to put locally registered AIFs at a disadvantage as they likely miss out on larger deals because of the inability to bring in co-investors. Foreign PE-VC funds, on the other hand, do not have such restrictions as they are not covered under the AIF norms.

SEBI said that fund managers can now offer any LP an additional co-investment opportunity beyond the existing investment being pooled into a portfolio company. "A separate CIV (co-investment) scheme shall be launched for each co-investment in an investee company, subject to safeguards to ensure that the scheme is used only for bona fide purposes. Certain regulatory requirements applicable to other AIF schemes shall be relaxed for CIV schemes," SEBI said.

"This will further increase the flow of private--especially domestic capital--to entrepreneurial and growth businesses. By limiting CIVs to accredited investors, SEBI has also signaled a shift toward more principle-based, lighter-touch regulation for qualified participants," Gopal Srinivasan, chairman and managing director of PE firm TVS Capital, said in a statement.

Gopal Jain, managing partner at PE firm Gaja Capital and co-chair of the regulatory affairs committee of the Indian Venture and Alternate Capital Association (IVCA), also welcomed the decision.

"SEBI's decision to formalise co-investment schemes under the AIF framework marks a pivotal shift in how capital can be mobilised for India's private markets. By allowing fund managers to launch a dedicated co-investment vehicle for each deal, this move brings much-needed clarity, structure, and operational ease to a practice that's long been in demand by institutional and accredited investors," Jain said.

In another key decision, SEBI extended the exemption of the minimum promoter contribution threshold to banks, state-owned institutions, insurance companies, AIFs, and foreign PE and VC firms who hold at least a 5% stake in a company going public.

As of now, only promoters are exempt from the minimum holding period of one year for the equity shares acquired to be eligible for an offer for sale in case of an initial public offering.

This exemption is not available for equity shares arising out of conversion of fully paid-up compulsorily convertible securities. These securities include compulsorily convertible preference shares that PE/VC firms often use to invest in startups and other unlisted companies.

This results in certain investors not being able to participate in the offer for sale in an IPO. Extending the exemption to equity shares arising from conversion of fully paid-up convertible securities will facilitate such participation, SEBI said.

Settlement scheme for VC funds

SEBI made a few other decisions in its board meeting that affect PE/VC funds. The regulator said that it will introduce a scheme to expedite settlement by venture capital firms that have migrated to the AIF regulations but have been unable to wind down their older schemes within the specified timelines.

"The scheme is intended to provide expeditious settlement of the past non-compliance related to tenure of the scheme only, without any additional burden to investors," the regulator said.

The settlement amount includes Rs 1,00,000 for delay of up to one year in winding up a scheme and Rs 50,000 for every subsequent year of delay.

The move came after SEBI received a lukewarm response from VC funds with active investment vehicles governed by legacy regulations to migrate to its AIF framework.

In August 2024, SEBI had directed legacy funds that are registered as Venture Capital Funds (VCFs) under the erstwhile Venture Capital Funds Regulations, 1996, to take up a one-time option to migrate into the AIF system through its migration framework. The framework allowed VCFs to transition to Migrated Venture Capital Funds, a newly introduced sub-category under Category-I AIFs. The regulator had set a deadline for July 19, 2025, for legacy VC funds to migrate.

"The announcement of a settlement scheme for legacy venture capital funds is also a welcome step, providing a pragmatic path forward while ensuring accountability," said Jain. "Together, these reforms underscore the regulator's balanced approach to deepening the ecosystem while addressing legacy bottlenecks."

Published by HT Digital Content Services with permission from VC Circle.