Welcoming Angel Investors: SEBI’s in line with Union Budget

The Union Finance minister in his budget speech said:

“Angel investors bring both experience and capital to new ventures. SEBI will prescribe requirements for angel investor pools by which they can be recognised as Category I AIF venture capital funds.”

And SEBI did!

[Incidentally, the Union Finance Minister also said: “Small and medium enterprises, including start-up companies, will be permitted to list on the SME exchange without being required to make an initial public offer (IPO), but the issue will be restricted to informed investors. This will be in addition to the existing SME platform in which listing can be done through an IPO and with wider investor participation.” A brief write up on the same can be found here. SEBI has done this as well.]

Earlier this week, the Board approved amendments to SEBI (Alternative Investment Funds) Regulations, 2012 or AIF Regulations that provide a framework for registration and regulation of angel ‘pools’ under a sub-category ‘Angel Funds’ under Category I – Venture Capital Funds.

These funds shall be included in the definition of “Venture Capital Funds” under the AIF Regulations.

“Venture capital fund” has been defined to mean an Alternative Investment Fund that invests primarily in unlisted securities of start-ups, emerging or early-stage venture capital undertakings mainly involved in new products, new services, technology or intellectual property right based activities or a new business model.

A venture capital undertaking is essentially an Indian unlisted company engaged in manufacturing or provision of services that are not opposed to industrial policy, performing NBFC activity or involve gold financing.

SEBI envisages that angel investors could be of three types:

–       ‘Corporate’ angel investors – entities that have an INR 10 crore net worth or are a registered AIF/VCF.

–       ‘Individual’ angel investors – who have early stage investment experience/ experience as a serial entrepreneur/ be a senior management professional with 10 years experience and net tangible assets of at least INR 2 crores.

–        ‘Angel Funds’ – that have a corpus of at least INR 10 crore (as against INR 20 crore for other AIFs) and minimum investment by an investor shall be INR 25 lakh (may be accepted over a period of maximum 3 years) as against INR 1 crore for other AIFs. Additionally, the continuing interest by sponsor/manager in the Angel Fund shall be not less than 2.5% of the corpus or INR 50 lakh, whichever is lesser.

Eligibility for Investee Companies

Angel funds shall invest only in investee companies which:

a. are incorporated in India and are not more than 3 years old; and

b. have a turnover not exceeding INR 25 crore; and

c. are unlisted, and

d. are not promoted, sponsored or related to an industrial group whose group turnover is in excess of INR 300 crore, and

e. has no family connection with the investors proposing to invest in the company.

Minimum Investment Stipulation

Investment in an investee company by an angel fund shall be not less than INR 50 lakh and not more than INR 5 crore and with a lock in period of 3 years.

Advantages to the Industry

Angel investing gets its name from the fact that such investors are not looking to make swift profits and are willing to support a company on its long winding path to success.

Angel investors come with several benefits for new businesses, including some of the key benefits highlighted below:

1. Great source for funding for high growth enterprises that are unable to obtain any other financing owing to lack of a track record etc.
2. Companies can raise capital in lesser amounts and do not need to place with an institutional investor or go out in the market and meet with public listing norms.
3. Angel investors sometimes bring to the table their knowledge and expertise in a sector and can leverage their reputation to enhance the growth prospects of the company.
4. The agreements with such investors may not be as cumbersome as agreements with Banks/ lenders or other financial investors.

Disadvantages to Companies

Angel investors can turn into the unnecessary evil. Investee companies often sign the dotted line without much negotiating power and agree to unreasonable profitability projections, high rates of dividend, numerous representations and warranties and high rate of return on exit and numerous exit clauses that can leave the company high and dry in bad times.

Companies that enter into agreements with angel investors should ensure that:

–       such angel investors are duly registered with SEBI and possess valid certificates to that effect;

–       exit rights to provide a protection to the company with a long lock-in period;

–       profitability projections as stipulated in the agreements to be reasonable; and

–       control over sale of stake by angel investors.

Angel Investors in the UK and US

In the UK, angel investment differs from venture capital finance, which invests in businesses through managed funds, raised with private or public money. As is usual, the venture capital fund manages its assets through its manager and invests the money on behalf of the Fund. The Fund then returns the profit to the investors. Due to high costs of administration and the need to be very selective to ensure a return on the fund, VC funds are more risk averse and thus make fewer small investments in start and seed stage.

Business angels have achieved immense significance with respect to funding new ventures as they supply smaller amounts of capital to companies that cannot be economically funded by the established venture capital market.

There is also a regulatory framework for angel investments that both protect the business angel and the entrepreneurs. The angel investor should be registered as a High Net Worth or Sophisticated Investor, as defined by the Financial Services Authority (FSA) under the Financial Services and Markets Act 2000 (FSMA).

The biggest differentiating factor is that business angels make their own decisions about investing in a company, by directly meeting the entrepreneur etc. By default they conduct their own due diligence.

Of course, numerous angel investors can get together and form a syndicate, post that the lead angel investor takes the lead in dealing with the entrepreneur.

Angel investors then follow their deal either actively taking a role on the board or actively supporting the business, or may act passively as part of a group with a lead angel taking this role on their behalf.

In the US angel investors are mostly wealthy individuals who invest in high risk, early stage ventures by reserving a portion of their total investment portfolios to provide emerging companies with seed and startup capital through direct, private investments. Their goal is to achieve higher returns than the typical public markets provide. Most angels are in fact active investors – who contribute their time and experience, as well as offer introductions to valuable contacts essential to the company’s success – because they enjoy the thrill of helping entrepreneurs grow their businesses.

In these respects the angel investor concepts prevailing in UK and the US are quite similar. Most of the investor groups are in fact regionally concentrated. This also aids in effective due diligence and deal negotiation, which is done on a concerted basis.

The most common factor is that angel investors being directly involved in the investment process are not a heavily regulated segment.

Back to India

SEBI it appears is seeking to regulate a sector that does not need to be so regulated. Who is object of the regulation? Is the object to protect informed investors who willingly invest in start-ups?

What is this concept of an angel investor fund and how is sought to be differentiated from a venture capital fund? Are investors forming angel investor groups those that need regulation or protection?

As of now, since Angel Investor Funds are included in the definition of Venture Capital Funds, the same regulations that apply to a venture capital fund will apply to it. The target investments are also similar. So far the difference only appears in monetary thresholds that apply to the two categories.

All of these doubts, one hopes, will be cleared after the regulations are cleared.