Concepts in the AIF Industry

1The parties to a fund

• Sponsor: sets up the AIF and keeps a continuing interest (a stake) in it.
• Investment manager: makes and manages the investments and charges the management fee. In global terms, the manager is the general partner (GP).
• Trustee: where the AIF is a trust, it holds the fund's assets for investors and oversees the manager.
• Investors (contributors): commit money to the fund. Globally they are called limited partners (LPs).
• Service providers: custodian, registrar and transfer agent, fund accountant, auditor, valuer, legal counsel and distributors.

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2Commitments, drawdowns and closes

• An investor signs a capital commitment: a promise to invest up to an agreed amount over the fund's life.
• The manager draws money only when needed, through a drawdown (or capital call). Each investor pays its share within a notice period.
• Contributed (paid-in) capital is the amount drawn so far. Uncalled commitment is what remains.
• First close: the date the fund first accepts commitments and can start investing. Final close: the date after which no new investors are admitted.
• Investment (commitment) period: usually the first few years, when new investments are made. Later years are spent growing and exiting the investments.
• Vintage year: the year the fund made its first investment (or held its first close). Funds are compared with others of the same vintage.

Example An investor commits ₹1 crore. After two drawdowns of 20% each, contributed capital is ₹40 lakh and the uncalled commitment is ₹60 lakh.

A defaulting investor who fails to meet a drawdown may face penalties set out in the fund documents, such as interest, loss of rights, or a forced sale of their interest.

Remember

• Commitment = promise; drawdown = actual payment; uncalled = commitment − contributed.
• First close starts the fund; final close ends fundraising.

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3The J-curve

In the early years, a PE or VC fund pays fees and expenses while its investments are still young and valued near cost. So its returns are usually negative at first. As investments mature and are sold at a profit, returns rise. Plotted over time, the cumulative return looks like the letter J.

Investors should expect this pattern and judge a fund only after enough years have passed.

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4Fees, hurdle, carried interest and the waterfall

• Management fee: an annual fee (for example 2%), usually charged on committed capital during the investment period and on invested capital or net asset value afterwards.
• Hurdle rate (preferred return): the return investors must receive, often 8–10% a year, before the manager shares in profits.
• Carried interest (carry): the manager's share of profits, typically 20%, paid only after investors get back their capital plus the hurdle.
• Catch-up: after the hurdle is met, the manager receives a larger share (sometimes 100%) of the next profits until it has "caught up" to its agreed share (for example 20%) of all profits.
• Waterfall: the order in which distributions are paid:
  1. return of investors' contributed capital;
  2. the preferred return (hurdle) to investors;
  3. the manager's catch-up, if any;
  4. the remaining profits split, for example 80% to investors and 20% to the manager.
• European (whole-fund) waterfall: carry is paid only after investors get back all their capital and hurdle across the whole fund. It favours investors.
• American (deal-by-deal) waterfall: carry can be paid on each profitable deal as it exits. It favours the manager and needs a clawback.
• Clawback: the manager must return excess carry if, at the end, it has received more than its agreed share.

Example A fund draws ₹100 crore and returns ₹180 crore in total. Profit = ₹80 crore. With a 20% carry and full catch-up, the manager's carry is 20% × ₹80 crore = ₹16 crore, and investors receive ₹164 crore.

Remember

• Waterfall order: capital → hurdle → catch-up → split.
• European waterfall = whole fund, investor-friendly. American = deal by deal, needs clawback.

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5Measuring fund returns

• IRR (internal rate of return): the annualised return on the actual timing of cash flows into and out of the fund. It is sensitive to timing: quick exits raise IRR.
• MOIC (multiple on invested capital): total value ÷ invested capital.
• DPI (distributed to paid-in): cash distributed ÷ paid-in capital. It shows realised returns.
• RVPI (residual value to paid-in): remaining net asset value ÷ paid-in capital. It shows unrealised value.
• TVPI (total value to paid-in) = DPI + RVPI.

Example Paid-in capital ₹10 crore; distributions so far ₹8 crore; remaining NAV ₹12 crore. DPI = 0.8x, RVPI = 1.2x, TVPI = 2.0x.

A high TVPI with a low DPI means most of the value is still on paper. DPI shows what investors have actually received.

Remember

• TVPI = DPI + RVPI.
• DPI = cash in hand; RVPI = paper value.
• IRR measures speed; multiples measure size.

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6Other common terms

• Co-investment: investing directly alongside the fund in a particular deal, usually with lower or no fees.
• Fund of funds: a fund that invests in other funds.
• Secondaries: buying or selling existing fund interests or portfolios from investors who want to exit early.
• Side letter: a separate agreement giving a particular investor specific terms.
• Most-favoured-nation (MFN) clause: lets an investor claim better terms given to other similar investors.
• Key person clause: if named key people leave the manager, investing may be suspended.
• Distribution in kind: distributing securities instead of cash.

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