Alternative Investment Fund Structuring

1Legal forms

An AIF can be set up as a trust, a company, a limited liability partnership (LLP) or a body corporate.

• Trust: the most common form in India. It is flexible, easy to set up and run, and gives Category I and II funds pass-through tax treatment (chapter 12). Governance rests with the trustee.
• LLP: gives partners limited liability and a partnership-style contract, but is less familiar to many investors and lenders.
• Company: well understood, but corporate law formalities and taxation at the company level make it less attractive for most funds.

Remember

• Most AIFs are trusts: flexible, familiar, and tax pass-through for Cat I/II.

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2The trust structure

• Settlor: creates the trust with a nominal amount, often the sponsor.
• Trustee: holds the trust property for the beneficiaries and oversees the manager. It is often a professional trustee company.
• Contributors (investors): sign a contribution agreement and become beneficiaries of the trust to the extent of their units.
• Investment manager: appointed under an investment management agreement. It makes investment decisions and charges fees.
• Sponsor: sets up the fund and keeps the required continuing interest.

Key documents: the indenture of trust (trust deed), the investment management agreement, the contribution agreement and the PPM.

Remember

• Trust deed + investment management agreement + contribution agreement + PPM.

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3Schemes and classes of units

• One AIF can launch several schemes, each with its own PPM, corpus, portfolio and tenure.
• Within a scheme, there can be classes of units with different terms, for example different fee levels for larger investors or for the sponsor.
• Investors in a scheme generally have pari passu (equal) rights in the scheme's investments. SEBI allows differential rights only within limits, with wider flexibility for large value funds and schemes for accredited investors only.

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4Foreign investors and offshore structures

• Foreign investors can invest in Indian AIFs directly, under the foreign exchange rules for investment in AIFs.
• Many managers use a feeder fund offshore (or in GIFT City) that pools foreign money and invests in the Indian AIF. In a master-feeder structure, several feeder funds invest in one master fund.
• A fund in GIFT City (IFSC), regulated by IFSCA, can pool foreign and Indian money in foreign currency.
• An AIF whose sponsor or manager is foreign-owned and controlled may be treated as foreign investment, which brings sector and pricing conditions under the FDI rules.

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5Co-investment structures

• A co-investment lets selected investors invest more in a particular portfolio company alongside the fund.
• SEBI's framework allows co-investment through a separate co-investment scheme of a Category I or II AIF for its accredited investors, with its own bank and demat accounts, ring-fenced from the main scheme.
• Co-investment terms may not be better than the main fund's terms in the same company, and the co-investment must exit at the same time as the main fund. Co-investment is capped at three times the investor's contribution to that company through the main scheme.

Remember

• Co-investment: separate scheme, accredited investors, no better terms, same exit, up to 3×.

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6Key terms in a term sheet

Exam trap A larger sponsor or manager commitment ("skin in the game") better aligns the manager's interests with investors'.

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