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Startups

Angel Fund Guidelines: Helps the Superangels, Keeps Out Smaller Investors

SEBI has introduced new guidelines for Angel Funds. As I’ve said recently, this is an absolutely important requirement in order for startups to avoid the “Startup Tax” (, a tax regulation that classifies investment as “income” if it is at a premium to the “par” value of a share of a company.

(Read the free Startup Tax e-Book)

The tax laws allow angel funds to skirt this rule, but what an angel fund actually means was left to SEBI. And this is what SEBI has said, in simple terms:

Angel funds a sub-category of SEBI AIF Cat-1, Like Venture Capital Funds with Only 25 Lakh Minimums

The SEBI Alternative Investment Fund (AIF) regulation is what allows pools of capital to be used in India to invest in anything. AIFs include Venture Capital Funds (VCFs) as a Category 1 player. An Angel fund will be a sub-category under the definition of VCFs. This sounds complicated, but we’ll get to that.

Other AIF investors, including those in VCFs, need to put in at least Rs. 1 crore (10 million) each.

But for Angel funds, the requirement per investor is only Rs. 25 lakh. (2.5 million) This amount can be amortized over three years, so the investor can spread the money over a period.

My view: AIF Cat-1 regulations are a pain. You can’t get new investors once you’ve launched a fund. (Close-ended) Risk and portfolio reporting requirements are detailed, with items like foreign exchange risk, detailed valuation methodology etc. Investments must be “revalued” every six months. There needs to be an office and detailed record keeping, that SEBI can inspect on demand.

However, there’s no other alternative, so the regulatory cost must be paid.

Angel Investors Must Meet Criteria for the Badge

Want to be an angel investor? You gotta have

  • Early stage investment experience, or
  • Been a serial entrepreneur, or
  • Had 10 years experience as a senior management executive

and

  • Have Rs. 2 crore (20 million, or $350,000 ) in tangible assets.
  • Companies that want to become Angel investors would need Rs. 10 cr. (100 million) net worth

My View: The entry criteria would have qualified me (I’m a serial entrepreneur) but I don’t have the Rs. 2 crore tangible net worth. That means I can’t be an investor in an angel fund, which makes total sense: The Rs. 25 lakh minimum, with a net worth of less than Rs. 2 crore, is probably a good idea.

If people like me want to invest in a company and can’t meet the above criteria, they should just go in on their own and not create a SEBI regulated AIF entity called a venture fund. Yes, the tax issue can be skirted – if you invest using a convertible debt instrument, it’s just a loan convertible to debt later at a certain valuation.

If you co-invest along with an “Angel Fund” at the same valuation but an amount less than 25 lakhs, you can quite easily prove to income tax authorities why the “premium” was justified – after all, a SEBI registered AIF Category 1 fund did the valuation, and they know best. Income tax problems solved.

Angel Funds Need Minimum Rs. 10 crore

Oh yes. You need Rs. 10 crore (100 million) in “corpus”. At the minimum, you need 40 investors with the 25 lakh commitment each. (Regular AIFs need 20 crore)

My view: This might sound like a big deal, but it’s not. Remember, like I’ve said in the last point, you don’t need to be an investor in an angel fund to actually do angel investments. If you do, and you qualify, it’s not such a bad idea to get a corpus of $2 million (Rs. 10 crore) together.

The Angel Fund “Manager” Must have 2.5% Skin In The Game, or 50 lakh

In the spirit of AIF regulations, all managers need to have their skin in the game, meaning they own a part of the fund. For regular AIFs the limit is Rs. 5 crore (50 million) or 2.5%, whichever is lower.

However, for angel funds, the manager needs to invest Rs. 50 lakh (5 million) or 2.5%, whichever is lower.

My view: It’s very important to have skin in the game. You lose when the fund loses. There’s no greater motivation to succeed. However, for people who don’t have enough money to invest, but can manage a fund, this is a fairly hard barrier.

Restrictions on Angel Investment

To avoid the abuse of angel investment as a vehicle to give bribes or avoid taxes, there are some specific rules that invested companies need to meet:

  • Indian incorporation, and less than 3 years old
  • Have a turnover of less than Rs. 25 crores
  • Are not listed
  • Have no relation to any industrial group whose turnover is 300 cr. or more
  • Has no family in the Angel fund

My View: It’s very unlikely that an early stage company wouldn’t meet this criteria. The industrial group connection and family issue are to prevent abuse.

The family regulation is funny. Venture Capital funds can invest in their own family-own companies!

Each Invested Company Must Get 0.5 to 5 Crore, Locked in for 3 years

Angel funds have to buy in at least Rs. 50 lakh (5 million) and a maximum of Rs. 5 crore (50 million) of any company.

They also have to stay invested for at least 3 years.

My View: Nothing less than Rs. 50 lakh? On principle, I think that’s a good restriction. Companies need more money than that nowadays, and this is an organized fund, honestly, so most investments would meet this criteria anyhow. If someone really wants lesser the deal can be to invest Rs. 50 lakh in multiple “tranches” based on some forward looking milestones that need to be met.

Nothing more than 5 crore? That’s strangely limiting when an investor needs to continue to invest in subsequent rounds to maintain its shareholding percentage. This amount could exceed the 5 crore required

The Three year lock-in is also strange. The waterfall model of investment means an early investor will be bought out by a subsequent investor (a VC fund or such), who might want to deploy more money than the company needs. In which case, it needs to offer existing investors a partial or complete exit.

What About the Fees?

Currently AIFs have heavy fees.

  • Rs. 100,000 to apply
  • Rs. 500,000 to register
  • Rs. 100,000 per individual fund.

There’s no indication of whether these will be relaxed for Angel funds. These fees are difficult to justify at an angel level of investment.

The Judgement: Startup Tax Is Still A Problem

I think the regulations allow a wannabe-VC-fund to now invest in companies. But it’s just a mini-venture-capital-fund, and not really something that serves the purpose for angel investment.

When I complained about the “Startup Tax”, it was about a specific use-case that is probably the most common in early startups. When a company gets early stage investment by angel investors, at a valuation that is a premium because that’s how the market works, it will have to pay tax if it can’t justify the premium.

The tax department said they’d solve it by allowing SEBI to define what an “angel” means, to keep them out of that regulation. (The regulation was created because politically connected companies were being invested into
, by corporates, at a massive premium, and there was no taxability involved)

SEBI has now defined Angels as rich investors who pool in capital, but aren’t rich enough to be venture capital investors. Essentially what SEBI is saying is that if you want to invest in an early stage startup, you have to find a fund that has gone through the SEBI hoopla, invest in it, and convince that fund’s manager that the “pool” needs to invest in that company.

This might not fly with many of the angels that currently invest, and they might still go their own way directly investing, even if it means dealing with the Startup Tax issue.

However, nowadays there is more interest in “superangels”. Funds that buy stakes in 500 companies. Funds that have a lot of money and spread it around. Funds that invest in the whole ecosystem, including incubating companies. Funds where money is collected from investors, pooled and invested by managers. For them, this regulation is a brilliant deal, but with a little more money they could register as venture capital AIFs in the first place.