Alternative Investment Funds (“AIFs”/ “Funds”) are privately pooled investment vehicles which collects funds from investors, whether Indian or foreign, for investing such funds in accordance with a defined investment policy for the benefit of their investors. AIFs in India are governed by the Securities and Exchange Board of India (Alternative Investment Regulations), 2012 (“AIF Regulations”) and regulated by the Securities and Exchange Board of India (“SEBI”). AIF Regulations are based on the premise that AIFs are a high-risk asset class, in which only sophisticated and well-informed investors participate. AIF Regulations, therefore, emphasize on the investors being informed of all material information regarding the AIFs and whenever any material changes are introduced therein, investor consent is sought prior to executing such changes. To read more about the structure of an AIF and key participants involved in the AIFs, please click here.
Private Placement Memorandum (“PPM”) is considered the information memorandum for AIFs which contains all the necessary information about the AIFs. PPMs are required to contain all material information about the AIF including respect to (i) background of the key investment team of the manager, (ii) targeted investors, (iii) tenure of the AIF or scheme, (iv) investment strategy, (v) risk management tools, etc. Therefore, PPM is a document created with the intention to sell investments in securities to private investors and explain the details of an investment to potential investors.
Prior to the year 2020, there was no prescribed format for PPM. Therefore, there was a risk that investor may receive information in a complex form and / or receive less information related to AIFs, such as, little information on potential conflict of interests, risk factors etc. To ensure that minimum standard of information is available and facilitate the processing of AIF registration applications in a time bound manner, SEBI has issued a template for PPM for all categories of AIFs. The template PPM focus’ on increasing disclosures and streamlines presentation of necessary information in the PPM. The templates for PPM as issued by SEBI can be accessed here.
Following are certain important sections in a PPM which a Fund or a scheme under a Fund (“Scheme”) may consider while drafting the PPM:
1. Investment manager and investment committee –
(i) Appointment of investment manager - The AIF Regulations contemplate that the manager of a Fund / Scheme must be distinct from the AIF. Such investment manager must be appointed by way of investment management agreement. The Fund / Scheme is required to disclose all the essential details of the investment manager such as, name of the entity, registered address, etc. in their PPM.
(ii) Management fees of the investment manager – A management fee is charged for the management services provided by the investment manager of the Fund. The Fund / Scheme is required to disclose the management fees proposed to be charged by such investment manager. It is pertinent to note that, the AIF Regulations do not define the manner / quantum of management fees which may be charged by an investment manager. The investment manager may either charge a fixed fee, or a variable which could be a function of the Fund’s performance, or in any other manner as commercially considered appropriate by the investment manager and agreed with the investors.
(iii) Track record of the investment manager – The Fund / Scheme shall be required to disclose in the PPM the track record of the investment manager since investors would be interested to know the skill, experience, and competence of the investment manager before making an investment.
(iv) Investment committee – The Fund / Scheme shall be required to disclose details with respect to the terms of reference of the investment committee constituted for approving the decisions of the Fund / Scheme in their PPM. The investment manager may constitute an investment committee (by whatever name called), to approve the decisions of the Fund / Scheme. Such constitution of the investment committee will be subject to conditions specified by SEBI from time to time. The investment committee may comprise internal and / or external members such as employees / directors / partners of the investment manager, nominees of the sponsor, employees of group companies of the sponsor / manager, domain experts, investors, or their nominees, etc.
The Fund / Scheme may also note that, in the event an external member is appointed in the investment committee, the name of such external member must be disclosed in the PPM. If the name of such external member is not disclosed in the PPM or agreement made with the investor or any other scheme documents at the time of on boarding investors, then such external member must be appointed only with the consent of at least 75% (seventy-five per cent) of the investors by value of their investment in the Fund / Scheme.
2. Investment strategy and process –The Fund / Scheme may provide a tabular chart in the PPM to outline the areas of investment and strategies related to investment in various portfolio companies. The Fund / Scheme may also incorporate a process in their PPM depicting the investment decision-making process. This will give investors a comprehensive idea of the ultimate investment objective and strategy.
3. Investor charter – An Investor Charter is a brief document containing details of services provided to investors, grievance redressal mechanism, responsibilities of the investors etc., at one single place for ease of reference. SEBI has mandated the Fund / Scheme to incorporate a section in the PPM on the ‘Investor Charter’. This was introduced with a view to keep the investors informed about various activities pertaining to AIFs and aimed at bringing further transparency about investor grievance redressal mechanism.
4. Risk factors - Risk factors are disclosures of the potential risks that every Fund / Scheme may consider disclosing to their investors in order to help investors to take an informed investment decision. Risk factors must be drafted with specificity, tailored for each industry type, offering structure, and investment strategy or business plan. SEBI has laid down certain risk factors in its template PPM. The list is not exhaustive in nature and the Fund / Scheme may amend the list based on its requirement. We have mentioned a few risk factors below:
(i) Risk related to portfolio investments – Fund / Scheme shall disclose the following common risk associated with the portfolio investments such as (a) return of capital contributions from such portfolio investments; (b) risk related to the exit of the Fund / Scheme from such portfolio investments and possibility of distribution in kind; (c) risk with regards to ability of the Fund / Scheme to raise significant capital, etc
(ii) Risk related to Fund / Scheme structure - This section will be specific to the structure adopted and attendant risks associated with the structure of the Fund / Scheme. Certain common themes across Fund / Scheme structure could be: (i) performance risk; (ii) concentration risk; and (iii) risk associated with reliance on the trustee (in case applicant is the trust), manager and other decision-making committees, etc.
(iii) Regulatory risk factors - Risk associated with obtaining SEBI registration and cancellation / suspension of SEBI certificate / other action by SEBI that may impact the operations of the Fund / Scheme. Other regulatory risks may include company law, takeover code, enforcement risks, regulatory approvals including loss of registration etc.
(iv) General risk factors – Fund / Scheme should list out the factors other than regulatory and statutory risks such as political, social, and economic risks in India and how investments of the Fund / Scheme may be impacted as a result of changes to it.
5. Annual audit - The Fund / Scheme shall be required to make a disclosure related to annual audit in the PPM. The Fund / Scheme shall be required to communicate the findings of such audit to the trustee or board or designated partners of the AIF, board of the manager and SEBI. It is to be noted that the requirement of annual audit is exempted for angel funds and Fund / Scheme where each investor commits to a minimum capital contribution of INR 700,000,000/- (Indian Rupees Seven Hundred Million).
6. Other key Scheme documents – The PPM is a disclosure document describing the offering, including its structure, strategies or business plan, risks, and management. The following contracts/documents shall constitute Scheme documents and shall be required to be filed with the PPM:
(i) Constitutional documents (depending on the structure of the Fund / Scheme, i.e., LLP, company, trust, body corporate);
(ii) Investment management agreement as executed between the trustee and the investment manager
(iii) Contribution agreement of the respective investor as executed between the trustee, the investment manager, and the relevant investor
(iv) Indenture executed between the settlor and the trustee; and
(v) Any other documents designated as Fund / Scheme document by the manager. Further, it is to be noted that, the Fund / Scheme should clarify in its documents as to which Fund / Scheme document prevails in case of any conflicts.
7. Distribution waterfall - A distribution waterfall records the order in which gains from pooled investment are allocated between investors in the Fund / Scheme. Generally, there are 4 (four) tiers in a distribution waterfall schedule
(i) Return of capital - First, 100% (one hundred percent) to the investors in proportion to their respective investment until the entire capital contributed by them is returned.
(ii) Preferred return – Second, 100% (one hundred percent) of further distributions go to investors until they receive the preferred return on their investment.
(iii) Catch-up tranche – Third, 100% (one hundred percent) of the distributions go to the sponsor or manager of the Fund / Scheme until it receives a certain percentage of profits
(iv) Carried interest - Fourth, in addition to the management fee, the investment manager will be entitled to a percentage share in the profits accrued upon realization of the Fund’s investments. This share in profits is known as carried interest and is typically paid out only after investors have been returned their capital contributions, together with a preferred return.
Additionally, a feature called "clawback" is frequently included in the PPM and is meant to protect investors from paying more incentive fees than required. In case of such an occurrence, the manager is obligated to pay back the excess fees. The Fund / Scheme shall be required to disclose a detailed flow of distribution waterfall in the PPM.
8. Filing of PPM through SEBI registered merchant banker - SEBI has mandated that PPM must be filed with SEBI through a merchant banker at least 30 (thirty) days prior to launch of the Scheme. SEBI has also mandated that the merchant banker must independently exercise due diligence of all the disclosures in the PPM and issue a due diligence certificate. The Fund / Scheme is required to submit such due diligence certificate along with the PPM to SEBI.
Our thoughts
PPM is typically the ‘first’ fundamental document shared with a prospective investor by the investment manager. The PPM creates the first impression for a Fund / Scheme especially if it’s a Fund started by a new fund manager and is considered as an important component in the development of mutually beneficial long-term relations between the investor and the Fund / Scheme. The AIF should carefully draft its PPM and should disclose all material, correct, and true information in a defined manner to ensure proper representation of the fundamentals and operations of the AIF. Further, the Fund / Scheme makes all necessary disclosures in the PPM to avoid any unwarranted liability which may arise out of misrepresentation / non-disclosure of material information. The PPM also forms the basis on which the contribution agreement is finalized under which investors invest in the Fund / Scheme. Therefore, it is recommended that utmost caution and effort is spent in drafting and finalizing the PPM.
Authors: Souvik Ganguly, Managing Partner, Akhil Ramesh, Senior Associate and Yogesh Chhajer, Associate.
The information contained in this document is not legal advice or legal opinion. The contents recorded in the said document are for informational purposes only and should not be used for commercial purposes. Acuity Law LLP disclaims all liability to any person for any loss or damage caused by errors or omissions, whether arising from negligence, accident or any other cause.