Co-investment is a framework through which an investor of an AIF can take additional exposure to portfolio companies of the fund through portfolio management services (PMS) of the fund. These additional shares bought by the AIF manager on behalf of any particular investor are held separately by the investor and are not part of the fund’s investments.
However, restrictions on co-investment in India have proved to be severely restraining, prompting several venture capital funds to make representations to the Securities and Exchange Board of India (Sebi) requesting the regulator to reconsider restrictions around the exit of such investments, people cited above said.
As per Sebi rules, such co-investment needs to be offloaded at the same time when AIF sells its shares. Also, the terms of sale, including the exit price, cannot be more beneficial to co-investments than the AIF itself.
“However, the LPs (limited partners or investors of AIF) may want to handle the co-investment portfolio independently and in many cases, they may want to stick with the portfolio company even after the AIF exits the same,” said Siddharth Pai, co-chair of regulatory affairs committee at industry lobby group Indian Venture and Alternate Capital Association. “Hence, relaxations to this rule would enable the investors of AIFs to exercise greater freedom in terms of exit, which is the global norm,” he added.
These restrictions are onerous for investors of close-ended AIFs since they often come with short and limited tenure. Typically, the lifecycle of a closed-ended AIF is between three and 10 years, after which the fund is mandated to liquidate all its portfolio holdings. As per the existing rules, co-investments, too, will have to be wound up, irrespective of the views of the investor.
In many cases, investors may want to hold on to their co-investment portion for a longer time than the AIF since they may be more bullish about the company and, hence, they are not comfortable having a divestment deadline, experts said.
“Since the terms and timing of exit from the co-investment have to mirror those of AIF, the same may deter co-investments as a co-investor may wish to take a long-term view on the investee company and continue to remain invested longer than the limited life close ended AIF, which under the regulations would not be possible,” said Tejesh Chitlangi, senior partner at financial services law firm IC Universal Legal.
Globally, co-investments are a prominent part of private equity funds.
In fact, in developed markets such as the US, PE fund managers are allowed to render their services to even third-party co-investors, i.e., investors who are not the fund’s LPs. Like, say, there is a wealthy investor who doesn’t want to buy the units of the fund and is interested to partner with the fund for specific portfolio investment. The PE fund manager is allowed to bring the investor onboard through the co-investment route.
“In India, the manager is not permitted to render advisory services to any third party co-investors other than the AIF investors,” Chitlangi said. “Such a provision technically restricts the prominent offshore co-investment model, whereby an offshore pooling vehicle seeks to invest alongside the AIF in the same investee companies, and is advised by the AIF manager,” he added.