The government is offering incentives to VC and PE funds, as it seeks to boost funding for startups. Among other things, the government will allow VC and PE funds go for a faster drawdown of the money they get from the state’s fund of funds.
The government will let venture capital (VC) and private equity (PE) funds to keep a larger portion of their profits, earn greater fees, and withdraw cash from the state’s pool of funds more quickly.
In 2016, the fund of funds for startups (FFS) was established to contribute to various alternative investment funds (AIFs) registered with the capital market regulator Sebi.
The FFS, which is managed by the state-owned Small Industries Development Bank of India (Sidbi), has invested over Rs 9,400 crore in 86 AIFs (the regulatory term for PE and VC funds).
Sidbi is the largest limited partner (LP) or investor in the country, contributing to the capital of VC and PE funds.
Sidbi informed AIFs in a letter dated April 29, 2022 that it would allow “accelerated drawdowns” of funds committed by the FFS while fund managers achieve internal rate of returns (IRR) greater than the hurdle rate — the minimum return a fund must achieve before profits can be shared among investors and fund managers.
“These are tangible measures to guarantee that FFS investments in eligible Indian AIFs may be made on better commercial terms in terms of management fee, carried interest for qualifying and performing fund managers, and greater flexibility in their day-to-day operations.”
Sidbi was successful. FFS has been one of the most important domestic institutional investors in Indian VC Funds, and the liberalization of many existing onerous terms in investment agreements will contribute in aligning such terms with those prevalent elsewhere,” said Tejesh Chitlangi, senior partner at IC Universal Legal.
Because AIFs frequently require a long time to raise capital from other investors, a faster drawdown of the money provided by the FFS will ensure that AIFs’ ability to make deals is not impeded.
The ‘carry’ or profit sharing (once the fund’s IRR exceeds the hurdle rate) is typically 80:20, with the manager receiving 20%.
If the IRR exceeds 25%, the FFS is now prepared to pass on 25% of the incremental returns (over and above the current IRR). If the fund earns an IRR greater than 30%, the carry share would be 30% (half the additional return).
According to the Sidbi letter, the FFS will consider paying a higher management fee if the fund is run by women, focuses on women-driven firms, priority regions, the agro-rural sector, financial inclusion, and is dedicated to investing in tier 2 and tier 3 centers.
The FFS is also willing to invest in funds with a corpus of more than Rs 1,000 crore as long as the investment manager is a domestic entity, the key persons or managers have previously managed funds to which Sidbi has made commitments, and exposure is capped at the same level as for a fund with a corpus of Rs 1,000 crore.