ALTERNATIVE INVESTMENT FUNDS (AIF)

A Note on Types, Formation & Registration, Compliance Applicability, and Business Model
(Governed by SEBI (Alternative Investment Funds) Regulations, 2012, as amended)

1. Overview
An Alternative Investment Fund (AIF) is a privately pooled investment vehicle, established in India, that collects
funds from sophisticated Indian or foreign investors for investing in accordance with a defined investment policy
for the benefit of its investors. AIFs are distinct from mutual funds and other SEBI-regulated collective
investment schemes and are not accessible to the general retail public. They are governed by the SEBI
(Alternative Investment Funds) Regulations, 2012 ("AIF Regulations"), as amended from time to time, most
recently through amendments in 2025 and 2026 that introduced measures such as the GARUDA framework for
faster scheme launches and revised thresholds for dormant/inactive schemes.

AIFs may be set up as a Trust, a Company, a Limited Liability Partnership (LLP), or a body corporate; in practice,
over 95% of Indian AIFs use the Trust structure because of its operational flexibility and governance simplicity.

2. Types of AIF
SEBI classifies AIFs into three broad categories based on investment strategy, risk profile, use of leverage,
liquidity, and the regulatory incentives attached to the underlying sector.

2.1 Category I AIF

Invests in start-ups, early-stage ventures, social ventures, SMEs, infrastructure, or other sectors considered
socially or economically desirable by the Government/regulators. These funds often enjoy incentives and are
generally not permitted to use leverage except for meeting temporary funding requirements.
• Venture Capital Funds (VCFs) — invest in unlisted, early-stage companies with high growth potential.
• Angel Funds — a sub-category of VCF that pools money from angel investors to invest in start-ups.
• SME Funds — invest in equity/equity-linked instruments of small and medium enterprises.
• Social Venture Funds — invest in enterprises with a social/developmental objective.
• Infrastructure Funds — invest in infrastructure sector projects.

2.2 Category II AIF

A residual category covering funds that do not fall under Category I or III and that do not undertake leverage
other than to meet day-to-day operational requirements (subject to permitted limits). This is the largest
category by number of registrations and AUM in India.
• Private Equity (PE) Funds — invest in unlisted companies at growth/buyout stage.
• Debt Funds / Private Credit Funds — invest primarily in debt or debt securities of investee companies.
• Fund of Funds — invest in units of other AIFs rather than directly in securities.
• Real Estate Funds and Distressed Asset / Special Situation Funds.
2.3 Category III AIF
Employs diverse or complex trading strategies, including investment in listed or unlisted derivatives, and may
use leverage (subject to SEBI-prescribed limits, including limits set by the AIF's own Board/governing body and
disclosed in the PPM). This category includes hedge-fund-style vehicles.
• Hedge Funds — pursue long/short, arbitrage, or other complex strategies for absolute returns.
• PIPE Funds (Private Investment in Public Equity) — invest in listed companies through private placement.
Additional naming/structural overlays: schemes open only to Accredited Investors must carry "AI Only Fund"/"AIOF" in
their name and enjoy relaxed regulatory requirements (e.g., lower minimum investment, faster launch); Large Value
Funds for Accredited Investors ("LVF") also have a distinct, lighter-touch regime. These are cross-cutting overlays available
within Categories I–III, not a fourth category.

Parameter Category I Category II Category III

Typical strategy VC, angel, SME, infra, PE, debt/credit, FoF, real Hedge-style, listed
social venture estate, distressed assets derivatives, PIPE

Leverage Not permitted (except Not permitted (except Permitted, subject to

temporary operational temporary operational prescribed/Board-
needs) needs) approved limits

Regulatory incentive Often eligible for No special incentive No special incentive

government/SEBI
incentives

Minimum corpus per scheme ₹20 crore (₹10 crore for ₹20 crore ₹20 crore
Angel Funds)

Investor concentration norm Single investee ≤ 25% of Single investee ≤ 25% of Single investee ≤ 10% of
investable funds investable funds investable funds

3. How to Form and Register an AIF

3.1 Choose the Legal Structure

An AIF may be constituted as a Trust (most common — via a registered Trust Deed under the Indian Trusts Act,
1882, or Registration Act, 1908), a Company (incorporated under the Companies Act, 2013), or an LLP
(registered under the LLP Act, 2008). The structure affects governance, taxation (pass-through status), and ease
of investor onboarding.

3.2 Constitute the Key Parties

• Sponsor — the person/entity that sets up the AIF and contributes the mandatory "skin in the game"
(continuing interest), evidenced by a net-worth certificate.
• Investment Manager — responsible for all investment decisions; must have at least one key personnel with
the NISM Series-XIX-C (or equivalent) certification and relevant experience.
• Trustee (for trust structures) — an independent entity that cannot be an associate of the sponsor or
manager; holds the trust property for investors' benefit.
3.3 Draft Constitutional & Offer Documents
• Trust Deed / MoA-AoA / LLP Agreement, as applicable to the chosen structure.
• Private Placement Memorandum (PPM) — the core disclosure document covering investment strategy,
target sectors, fee structure (management fee and carried interest), risk factors, key personnel, conflict-of-
interest policy, and fund terms.
• Investment Management Agreement between the AIF/Trustee and the Investment Manager.
• Contribution Agreement setting out investor commitments and drawdown terms.

3.4 File the Application with SEBI

Applications are filed online through SEBI's SI (Intermediary) Portal ([Link]) in Form A, along with:
• Sponsor and Investment Manager KYC, fit-and-proper declarations, and pedigree certificates.
• Track record and net worth certificates (CA-certified) of the sponsor/manager.
• Draft PPM and constitutional documents.
• Non-refundable application fee (paid to SEBI) and, on approval, the category-wise registration fee.
Registration fees broadly range from about ₹5 lakh (Category I) up to ₹15–20 lakh (Category III), with additional
scheme-level filing fees; exact fees are prescribed in the Second Schedule to the AIF Regulations and should be
verified on the SEBI website at the time of filing.

3.5 SEBI Review and Grant of Certificate

SEBI examines the application for eligibility, fit-and-proper status of the sponsor/manager/trustee, and
compliance of the PPM with the AIF Regulations. On satisfaction, SEBI grants a Certificate of Registration in Form
B under the specific category (and sub-category, where applicable), which remains valid until the AIF is wound
up. SEBI may also grant registration subject to specific conditions, and it can reject an application after giving the
applicant an opportunity to be heard, with the rejection communicated within 30 days.

3.6 Launch of Schemes

Each investment scheme under an AIF requires its own PPM to be filed with SEBI (typically routed through a
SEBI-registered merchant banker who furnishes a due-diligence certificate). Under the Fast-Track/GARUDA
mechanisms introduced in 2026, standard schemes can generally commence on-boarding investors within a
shorter window after PPM filing (subject to no adverse observation from SEBI), while Accredited-Investor-only
schemes and Angel Funds may benefit from further relaxed timelines.

Stage Typical Timeline

Entity formation (Trust/LLP/Company) + Investment 3–6 weeks

Manager incorporation

Documentation (PPM, agreements) and Form A 3–5 weeks

preparation

SEBI review and clarifications 4–12 weeks

Grant of Certificate of Registration Total: approx. 4–8 months end-to-end

Scheme-level PPM filing and launch (post AIF 10–30 working days (category/mechanism
 Stage Typical Timeline

registration) dependent)

4. Compliance Applicability
Once registered, an AIF and its Investment Manager/Trustee are subject to continuing obligations under the AIF
Regulations, SEBI circulars, and related laws (FEMA, Income-tax Act, PMLA, Companies/LLP/Trusts Act as
applicable to the vehicle chosen).

4.1 Investor Eligibility and Fund-Raising Norms

• Minimum investment per investor: ₹1 crore (₹25 lakh for employees/directors of the AIF or its manager).
• Maximum number of investors per scheme: 1,000 (49 for Angel Funds, consistent with the Companies Act's
private placement limit).
• Minimum corpus per scheme: ₹20 crore (₹10 crore for Angel Funds); the AIF must achieve this within the
timelines prescribed for the scheme.
• Sponsor/Manager continuing interest: typically the lower of 2.5% of the corpus or ₹5 crore for Category I/II
(2.5% or ₹5 crore for Category III with derivatives-only strategies, higher for others), aligning sponsor
interests with investors.
• Fund tenure: Category I and II AIFs are close-ended with a minimum tenure of 3 years; Category III may be
open- or close-ended.

4.2 Investment Restrictions

• Category I/II: concentration limit of not more than 25% of investable funds in a single investee company
(10% for Category III); Category II must generally hold a defined minimum proportion in unlisted securities,
though recent proposals allow limited flexibility toward lower-rated listed debt given the shrinking
unlisted-debt universe.
• Leverage: not permitted for Category I/II (barring temporary operational borrowing, capped and time-
bound); permitted for Category III subject to limits approved by the fund's governing body/Board and
disclosed in the PPM, with periodic reporting to SEBI.
• Related-party and conflict-of-interest transactions must be disclosed and approved per the PPM and
internal policies.

4.3 Governance and Operational Compliance

• Independent valuation of portfolio investments at prescribed intervals by an independent valuer.
• Custodian appointment mandatory once the AIF's corpus (or investor commitments) crosses the SEBI-
prescribed threshold.
• Compliance officer/compliance test report to be filed periodically confirming adherence to the Regulations.
• Dematerialisation of AIF units, where applicable, as mandated by SEBI's ongoing push toward demat
holding.
• Grievance redressal through SEBI's SCORES portal and disclosure of investor complaints.
4.4 Reporting and Disclosure
• Periodic (typically monthly/quarterly) reporting to SEBI on fund activity, portfolio, leverage (for Category
III), and material changes.
• Annual filing of audited financial statements and disclosure of material changes to the PPM to SEBI and
investors.
• Track-record and performance disclosure to prospective investors in line with SEBI's standardised
PPM/benchmarking norms.

4.5 Other Applicable Laws

• FEMA / RBI regulations for foreign investment into and by the AIF (downstream investment norms, sectoral
caps, reporting via FIRMS/single master form where applicable).
• Income-tax Act, 1961 — pass-through taxation for Category I/II AIFs (income taxed in the hands of
investors, subject to exceptions like business income); Category III generally taxed at the fund level.
• Prevention of Money Laundering Act (PMLA) — KYC/AML obligations for investor onboarding.
• Companies Act/LLP Act/Indian Trusts Act — depending on the chosen legal structure of the AIF and
Investment Manager.
Compliance obligations scale with category and strategy — Category III (leveraged, derivative-using) funds face
materially more intensive reporting than Category I funds. Sponsors should always verify the current Second Schedule fee
structure, thresholds, and any recent amendments (e.g., the 2025/2026 amendments) directly on the SEBI website before
filing, as these are periodically revised.

5. Business Model of an AIF

The AIF business model centres on pooling capital from a limited set of sophisticated investors and deploying it
through a professional Investment Manager in exchange for management and performance-linked fees, with the
Sponsor's own capital aligning incentives.

5.1 Key Participants and Revenue Flows

• Investors (Limited Partners) — commit capital via a Contribution Agreement; draw-downs are called over
the fund's investment period rather than paid upfront in full.
• Sponsor — sets up the fund and contributes the mandatory continuing interest, sharing downside risk with
investors.
• Investment Manager — earns a management fee (commonly 1.5%–2.5% of committed/invested capital per
annum) and carried interest / performance fee (commonly 10%–20% of profits above a hurdle rate) once
returns exceed a pre-agreed threshold.
• Trustee/Trustee Company — oversees fiduciary compliance for trust-structured AIFs, typically for a fixed
fee.
• Custodian, Valuer, Auditor, RTA (Registrar & Transfer Agent) — service providers ensuring asset
safekeeping, independent valuation, financial reporting, and unit administration.
5.2 Fund Lifecycle
1. Fundraising / First Close — Sponsor and Manager market the PPM to prospective investors and secure
initial capital commitments (first close), followed by subsequent closes up to final close.
2. Investment Period — capital is drawn down and deployed into portfolio companies/assets per the stated
strategy, typically over 2–4 years.
3. Portfolio Management Period — the Manager actively manages, monitors, and adds value to portfolio
investments (board seats, operational support, follow-on rounds, etc.).
4. Harvesting / Exit Period — investments are exited via IPO, strategic sale, secondary sale, or buyback, and
proceeds (net of fees/carry) are distributed to investors.
5. Wind-up — on completion of tenure (with permitted extensions), the fund is dissolved and the Certificate
of Registration lapses/is surrendered.

5.3 Fee and Return Structure (Illustrative)

Component Typical Range / Basis

Management fee 1.5%–2.5% p.a. of committed or invested capital

Hurdle rate 8%–12% p.a. preferred return to investors before carry accrues

Carried interest (performance fee) 10%–20% of profits above the hurdle, often with a catch-up clause

Sponsor commitment Lower of 2.5% of corpus or a prescribed cap, aligning sponsor and
investor interests

Fund expenses Setup costs, custodian/valuer/audit fees — usually capped as a %

of corpus and disclosed in the PPM

5.4 Revenue and Value-Creation Logic

The Manager's economics are driven primarily by scale (AUM growth through successive fund vintages) and
performance (carried interest on successful exits), which incentivises disciplined capital deployment and active
portfolio value-creation rather than passive holding. Because AIFs are close-ended (for Cat I/II) with a defined
investment horizon, the business model is inherently cyclical — fundraising, deployment, and exit phases recur
with each new fund vintage, and a track record from earlier funds is central to raising subsequent ones.

Disclaimer: This note is for general informational purposes and summarises the SEBI (Alternative Investment Funds) Regulations, 2012, as
amended (including 2025–2026 amendments). It is not legal, tax, or investment advice. Given that AIF regulations, fee schedules, and
thresholds are amended periodically, readers should verify current requirements on the SEBI website ([Link]) or with a qualified
professional before acting on this note.