SEBIAn Introductory Guide to Private Placement Memorandum – PART I

INTRODUCTION

Private Pooled Investment Vehicles (PPIV) have become a popular investment tool in the 21^st Century. These investment vehicles are made by collecting relatively small investments from a large group of people. A popular version of such PPIV’s is the Alternate Investment Fund (AIFs). An AIF can be described as a PPIV which collects foreign funds from a specific group of, often sophisticated investors, whether Indian or foreign, and invests the pooled funds in a well-defined and sophisticated investment policy.

The rise in the popularity of AIF allocation can be seen as a by-product of the start-up boom, requiring relatively lower investments. Many of the new-age entrepreneurs of India end up making multiple orders in return for the initial investment made by their backers. Thus, the ambition behind AIF’s is mainly driven by investors in both private equity (PE) and private debt of unlisted companies which can only be invested into through the AIF route.

AIFs are seen as PPIV’s for an elite class of investors usually consisting of high-net-worth individuals (HNI’s) as the minimum investment amount is Rs. 1 Cr for individuals and Rs. 25 Lakhs for angel investors.

The high barrier to entry makes AIFs stand out as innovative alternatives to typical assets like stocks, bonds, and debt securities. AIF investor pool is made up of sophisticated, experienced investors looking for innovative new opportunities such as different types of assets, such as venture capital, private equity, and hedge funds.

A Private Placement Memorandum (PPM), also called an Offering Memorandum, is a legally binding document that all AIF’s are mandatorily required to release to provide disclosures and clarifications to the investors.

The PPM is supposed to lay out the basic details about the company such as its financial status, business operations, potential risks, management team biographies, and other relevant information. The PPM is a pivotal piece of document as:

1. It informs potential investors about the details of the investment opportunity, aiding them in making informed decisions about whether to invest in the company.

2. It offers sellers some protection from liability associated with selling stock on the private market.

AIFs GOVERNANCE AND RULES IN INDIA

In India, AIFs are regulated by the Securities and Exchange Board of India (SEBI) under the Securities and Exchange Board of India (Alternative Investment Funds) Regulations, 2012 (AIF Regulations). The AIF Regulations are designed with the understanding that AIFs represent a high-risk investment category suitable for sophisticated and well-informed investors. Therefore, the regulations prioritize ensuring that investors are fully informed about all significant aspects of AIFs, and any substantial changes to the fund require prior consent from investors.

The AIF Regulations aim to establish funds through various legal entities such as Trusts, Companies, LLPs, or Body Corporates, with Trust being the preferred option in most cases. Typically, the parties involved in a Trust-based structure include the Fund, the Sponsor, the Trustee, and the Investment Manager. The main objectives of the AIF Regulations are to:

1. Regulate the activities of AIFs to protect investors’ interests.

2. Systemise and standardize the operation of AIFs.

3. Facilitate the growth of the alternative investment industry in India.

Thus, the AIF Regulations were introduced to bring clarity, transparency, and regulatory oversight to the rapidly growing alternative investment industry in the country.

SEBI, vide its circular dated October 21, 2021, has prescribed the modalities for filing of PPM through Merchant Bankers. A “Merchant banker” means any person who is engaged in the business of issue management- either by making arrangements regarding selling, buying, or subscribing to securities, or acting as manager, consultant, adviser, or rendering corporate advisory service in relation to such issue management; as defined in Securities and Exchange Board of India (Merchant Bankers) Regulations, 1992 (MB Regulations).

The Merchant Banker is responsible for conducting an independent due diligence process on all disclosures within the PPM. It must ensure the accuracy and sufficiency of these disclosures and issue a due diligence certificate according to the specified format.

When filing the draft PPM on the SEBI intermediary portal for registration of the AIF or prior to launching a new scheme, the Merchant Banker must submit the due diligence certificate along with other required documents. The PPM must also include details of the Merchant Banker. Additionally, AIFs must inform SEBI about any changes to the placement memorandum within one month after the end of each financial year. This notification, along with the due diligence certificate from the Merchant Banker, must be submitted through the Merchant Banker using the prescribed format specified by SEBI in its circular.

Additionally, any changes made during the submission of the final placement memorandum must be listed clearly in the cover letter as well as in the copy of the final placement memorandum.

In case the changes stipulated prove to be ‘Material’ in nature, meaning changes impacting the fundamental attributes of the fund/scheme, have to follow a certain procedure as specified in the guidelines. Since these changes significantly influence the decision of the investor to continue to be invested in the AIF, the existing unit holders have to be provided with an exit option.

The manager/sponsor is responsible for providing an exit to the dissenting investors within 3 months from the date of expiry of the last date of the offer for dissent.  The exit process shall not apply to cases where the AIF has the approval of 75% or more of unit holders by the value of their investment in the AIF.

The format stipulated for incorporating Material Changes is as follows:

The Circular further stipulates that the Merchant Banker engaged for the submission of the PPM must not have any affiliation with the AIF, its sponsor, manager, or trustee.

This additional regulatory measure aims to enhance investor safeguards, aligning the private placement process of an AIF more closely with the public issuance of shares by companies, where merchant bankers play a pivotal intermediary role.

Consequently, the introduction of an additional participant in the private placement process is anticipated to result in heightened scrutiny of the placement memorandum submitted to SEBI by merchant bankers.

AIF REGISTRATION PROCESS

The AIF Regulations further lays out detailed requirements as prerequisites for the registration of an AIF in India, under Regulation 4 of the AIF Regulations. As AIFs need to be mandatorily registered, non-compliance would render the AIF illegal. The following are the pre-requisites:

1. the memorandum of association in case of a company; or the Trust Deed in case of a Trust; or the Partnership deed in case of a limited liability partnership permits it to carry on the activity of an AIF;

2. the applicant is prohibited by its memorandum and articles of association or trust deed or partnership deed from making an invitation to the public to subscribe to its securities;

3. in case the applicant is a Trust, the instrument of trust is in the form of a deed and has been duly registered under the provisions of the Registration Act, 1908;

4. in case the applicant is a limited liability partnership, the partnership is duly incorporated and the partnership deed has been duly filed with the Registrar under the provisions of the Limited Liability Partnership Act, 2008;

5. in case the applicant is a body corporate, it is set up or established under the laws of the Central or State Legislature and is permitted to carry on the activities of an AIF;

6. the applicant, Sponsor and Manager are fit and proper persons based on the criteria specified in Schedule II of the Securities and Exchange Board of India (Intermediaries) Regulations, 2008;

7. The key investment team of the Manager of AIF must have –

• • adequate experience, with at least one key personnel having not less than five years of experience in advising or managing pools of capital or in fund or asset or wealth or portfolio management or in the business of buying, selling and dealing of securities or other financial assets; and
  • at least one key personnel with professional qualification in finance, accountancy, business management, commerce, economics, capital market or banking from a university or an institution recognized by the Central Government or any State Government or a foreign university, or a CFA charter from the CFA institute or any other qualification as may be specified by the Board;

1. the Manager or Sponsor must have necessary infrastructure and manpower to effectively discharge its activities;

2. At the time of registration, the applicant must clearly specify the following details about the AIF:

• • investment objective,
  • the targeted investors,
  • proposed corpus,
  • investment style or strategy and
  • proposed tenure

1. whether the applicant or any entity established by the Sponsor or Manager has earlier been refused registration by the Board needs to be declared as well.

In addition to the above, Regulation 3 (4) of the AIF Regulations mandates that applicants shall register their AIF as being either one of the following 3 categories:

1. Category I: AIFs that invest in start-up or early-stage ventures or social ventures or SMEs or infrastructure or other sectors or areas that the Government or regulators consider as socially or economically desirable. The AIF Regulations further exemplify such AIFs as ideally including venture capital funds, SME Funds, social venture funds, infrastructure funds, and such other AIF as may be specified.

Focuses on investments in start-ups, SMEs, and socially and economically viable projects. This category includes VC funds, SME Funds, Social Venture Funds, Infrastructure Funds, and other funds as specified by government or regulatory authorities.

2. Category II: AIFs that do not fall in Category I and III and which do not undertake leverage or borrowing other than to meet day-to-day operational requirements and as permitted in the SEBI (Alternative Investment Funds) Regulations, 2012.

Targets investments in equity and debt securities funds in this category may leverage or borrow to meet operational needs within the acceptable conditions outlined in the AIF Regulations. Examples include Real Estate Funds, PE Funds, and funds for distressed assets.

3. Category III: AIFs that employ diverse or complex trading strategies and may employ leverage including through investment in listed or unlisted derivatives.

Aims at achieving short-term returns through complex trading strategies. These funds employ diverse or intricate trading strategies and may use leverage, including investments in listed or unlisted derivatives. Examples include Hedge Funds and Private Investment in Public Equity Funds (PIPE). Applicants can apply for registration as an AIF under one of these categories and their respective sub-categories, as applicable.

AMLEGALS REMARKS

The significance of analysing  the PPM lies in its role as a crucial document for both investors and issuers in the AIF market. As AIFs are catered towards high capital investment, the risk of failure or fraud can cause significant losses to otherwise powerful assets. Thus, the PPM serves as a comprehensive disclosure tool, providing potential investors with essential information about the investment opportunity, including its terms, risks, and objectives.

It is pivotal to note that thorough understanding and adherence to the information outlined in the PPM are essential for making informed investment decisions and mitigating potential risks. Whether you are an entrepreneur seeking capital or an investor seeking opportunities, the PPM serves as your compass, guiding you through the complexities of private placements with clarity and transparency.

In the next blog, we will delve into the important aspects that should be factored while drafting a PPM.

-Team AMLEGALS assisted by Mr. Shaurya Pandey (Intern)

For any query or feedback, please feel free to get in touch with mridusha.guha@amlegals.com or jason.james@amlegals.com