How to navigate the sunset years of a Fund

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Introduction

SEBI (Venture Capital Funds) Regulations, 1996 (“VCF Regulations“)[1] and the SEBI (Alternative Investment Funds) Regulations, 2012 (“AIF Regulations“) are robust and govern many aspects of a fund life, including the time period for which a fund can carry on its activities and the manner in which it will be wound up.

In ordinary course, these provisions may aid in ensuring that the fund is set up with the objective of winding up in a time bound manner and thereby ensuring that investors are given returns in a timely manner. However, in times of crisis, these regulations may prove challenging for fund managers to comply with.

This article seeks to highlight the challenges faced by fund managers where their funds are nearing the fund life and what are the steps they can consider adopting.

VCFs/AIFs – What is the Law?

VCFs: Under the VCF Regulations, upon expiry of the term of the VCF mentioned in the placement memorandum, the VCF is required to inform SEBI and be wound up within a period of 3 months from the date of intimation to SEBI.

AIFs: Under the AIF Regulations, upon expiry of the term of the AIF mentioned in the placement memorandum, the AIF can extend its fund life by up to 2 years with 66.67% investor consent (by value). Post the expiry of the term, AIFs are required to inform SEBI and be wound up within a period of 1 year from the date of intimation to SEBI.

What can a fund do when life comes to an end?

Option 1: Extend the term of the fund

Before the stipulated term of the fund as stated in the PPM comes to an end, one option is for the fund manager to extend the term. This is possible for VCFs through an amendment to the fund documents, in accordance with the amendment process set out under the fund documents. For AIFs, the fund life can be extended, in accordance with the AIF Regulations.

However, any fund manager selecting this option should take note of the following:

· Approval process: Given taking consent of investors is a cumbersome process, fund managers should informally ascertain the total approvals that they are likely to get before putting the matter to vote. Considerations of taking a deemed consent needs to be carefully evaluated.

·  SEBI Orders: In the matter of Cinema Capital Ventures Fund (EAD-2/SS/SK/2018-19/2550-2556 dated March 29, 2019), relating to extension of term of fund registered as VCF, SEBI has held that that inability of the manager to liquidate the assets of the fund cannot be a reason to continue the term beyond the period specified in the VCF Regulations. Further, in the matter of CIG Realty Fund (EAD-2/SS/VS/2018-19/2540-2545 dated March 28, 2019), relating to the same issue, SEBI has held that VCF Regulations do not give flexibility to modify the maturity period of a fund after raising money from investors. Further, the order also states that the term cannot be extended by amendment of the fund documents. In light of these orders, fund managers should attempt to liquidate assets in a time bound manner and ascertain which option works best for them, both legally and commercially.

Option 2: In-kind/in-specie Distribution

Fund manager may make an in-kind distribution to its investors[2]. However, any fund manager selecting this option should take note of the following:

· Private placement norms: While making an in-kind distribution, fund managers need to bear in mind the private placement norms applicable to companies under the (Indian) Companies Act, 2013.

· Dilution of rights: In-kind distributions may result in investors holding a minuscule stake in the portfolio companies and therefore special rights and privileges/ability to exit/board seat may get diluted.

Option 3: Fund Buy-out

This can be via sale of units of the fund to a third party purchaser or sale of the portfolio to another fund.

In exercising this option, fund managers will need to be factor in any pending litigations/arbitrations against the fund or portfolio investments, restrictions on transfer of securities under the portfolio agreements, stamp duty and tax implications.

Conclusion

The COVID 19 pandemic has created a lot of pressure on fund managers to effectively manage their funds and get exits in a time bound manner. For funds that are nearing their fund life, it is critical to evaluate options, understand investor sentiment and accordingly chalk out a plan of action. Time is of the essence and taking positive steps will go a long way in retaining confidence of investors and the regulators.

Authors:

Pallabi Ghosal, Partner
Hetvi Doshi, Associate

Footnotes:

[1] The erstwhile VCF Regulations have been repealed. However, there are several funds in the market that continue to be governed by the VCF Regulations as they are not raising fresh capital and therefore, have been permitted by SEBI to continue to operate under the VCF Regulations.

[2] Both the VCF Regulations and the AIF Regulations require an approval of at least 75% of the investors for making such a distribution.

Date: June 5, 2020