Categories of AIFs (Category I, II, III)

Categories of AIFs (Category I, II, III)

All the types of funds that have been described above are divided into three categories under the SEBI (AIF) Regulations for the purposes of registration and other operational requirements. These categories are mentioned below.

Category I AIF – is an AIF that invests in start-up or early stage ventures or social ventures or SMEs or infrastructure or other sectors or areas which the government or regulators consider as socially or economically desirable and shall include venture capital funds, SME Funds, social venture funds, special situation funds, infrastructure funds and such other AIFs as may be specified under the Regulations from time to time. Other funds that are considered economically beneficial and are provided special incentives by the government or any regulator are also considered as part of this Category.

Category II AIF – is an AIF that does not fall in Categories I and III and which does not undertake leverage or borrowing other than to meet day-to-day operational requirements or as permitted in the Regulations. For this purpose, AIFs such as private equity funds or debt funds for which no specific incentives or concessions are given by the government or any other Regulator are included under this Category.

Category III AIF – is an AIF that employs diverse or complex trading strategies and may employ leverage including through investment in listed or unlisted derivatives. AIFs such as hedge funds or funds which trade with a view to make short term returns or such other funds which are open ended and for which no specific incentives or concessions are given by the government or any other Regulator are included under this Category.

It may be observed from the above definitions that under the SEBI (AIF) Regulations, AIFs that are economically important or socially impactful may enjoy greater benefits, under Category I AIFs. Angel Funds, Venture Capital Funds, SME Funds, Infrastructure Funds, Special Situations Funds and Social Impact Funds, that are considered important for employment generation, qualify under Category I AIFs. Other AIFs that invest in unlisted securities, such as Debt Funds, Private Equity Funds and Pre-IPO Funds fall under Category II AIFs. Those AIFs that deploy complex trading strategies in secondary listed markets, derivatives and or may also use leverage at fund level such as Hedge Funds qualify as Category III AIFs.

Being early stage investors, Venture Capital Funds are allowed to invest primarily in unlisted securities i.e. equity, debt, preference capital or other convertible securities, of start-ups, emerging venture capital undertakings or early-stage companies. Therefore, the definition uses the word ‘securities’ to provide latitude to structure the investments appropriately. However, according to the definition of Private Equity Funds, these AIFs are required to invest primarily in equity or equity linked instruments or partnership interests of investee companies. This is because being later-stage investors, Private Equity Funds are in a better position to take equity risks in investee companies. Similarly, funds structured purely as Private Debt funds also qualify under Category II AIFs. Below table compares and contrasts between the categories of AIFs.


Parameters

Category I AIF

Category II AIF

Category III AIF

Definition

Invests in start-ups, early-stage ventures, social ventures, SMEs, infrastructure or other sectors as may be specified.

All AIFs that do not classify under Category I AIF or Category III AIF.

Employs diverse or complex trading strategies and may employ leverage including through investment in listed or unlisted derivatives.

Scope

The sectors should be economically or socially desirable. Primarily the focus is on early-stage start-ups and unlisted ventures.

These funds that seek later stage investment opportunities do not use any leverage at fund level or indulge in complex trading operations.

These funds explore opportunities in primary and secondary markets through all types of securities including derivatives.

Risk strategy

Since early-stage ventures are subject to high mortality risk, these funds assume higher risks seeking higher return. But risk mitigation strategy is to invest in smaller tranches. Investors in this category have to invest a minimum of INR 1 crore (INR

25 lakh in angel funds). Generally, (subject to additional requirements for each sub-category), the AIF in this category has to invest primarily in unlisted companies or units of other Cat I AIFs. The maximum investment in a particular investee company cannot exceed 25% of the investible funds of the AIF scheme. Angel funds need to invest a minimum of INR 25 lakh and not more than INR 10 crore in a particular investee company.

Generally, less risky than Category III AIF. Primarily seek returns from value creation and unlocking value by investing in later stage companies. Investment should be primarily in unlisted investee companies or units of other AIFs. The maximum investment in a particular investee company cannot exceed 25% of the investible funds of the AIF scheme.

Complex risk-taking strategies including trading with leverage at fund level. Investment can be both in unlisted and listed companies as well as in other exchange-traded securities, structured products and derivatives. The maximum investment in a particular investee company cannot exceed 10% of the investible funds of the AIF scheme.


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