Documentation Required for Setting-up Angel Funds
PRIVATE PLACEMENT MEMORANDUM (PPM)
At the Offshore Fund level: PPM is the document that discloses all pertinent information to the investors regarding the company, proposed business operations of the company, structure of the transaction, the terms of the investment (share price, note amounts, maturity dates, etc.), potential risks for the investors, and details of the investment. Do not confuse the detailed disclosures and transaction structure in a PPM with the general information a business plan provides – they are not the same.
At the Onshore Fund level: AIF Regulations require that a concerned fund’s PPM should contain all material information about the AIF, including details of the manager, the key investment team, targeted investors, fees and other expenses proposed to be charged from the fund, tenure of the scheme, conditions or limits on redemption, investment strategy, risk factors and risk management tools, conflicts of interest and procedures to identify and address them, disciplinary history, terms and conditions on which the manager offers services, affiliations with other intermediaries, manner of winding up the scheme or the AIF and such other information as may be necessary for an investor to take an informed decision as to whether to invest in the scheme of an AIF[1].
SEBI has now directed fund managers to add by way of an annexure to the placement memorandum, a detailed tabular example of how the fees and charges shall be applicable to the investor and the distribution waterfall for AIFs.[2]
AIFs should also include disciplinary actions in its placement memorandum.[3] It has been clarified by SEBI that AIFs should also include a disciplinary history of the AIF, sponsor, manager and their directors, partners, promoters and associates and a disciplinary history of the trustees or the trustee company and its directors if the applicant for AIF registration is a trust.[4]
Any changes made to the placement memorandum submitted to SEBI at the time of the application for registration as an AIF must be listed clearly in the covering letter submitted to SEBI. Furthermore, such changes are required to be highlighted in the copy of the final placement memorandum.[5] In case there is a material change to the placement memorandum (factors that SEBI believes to be a change significantly influencing the decision of the investor to continue to be invested in the AIF), due to: (1) change in sponsor / manager, (2) change in control of sponsor / manager, (3) change in fee structure or hurdle rate which may result in higher fees being charged to the unit holders), existing unit holders unwilling to continue post such changes, shall be provided with an exit option.[6]
This change is critical for fund managers to note. Such disclosure reduces the space for ‘views’ being taken by a fund manager in a given liquidity event leading to distribution. It further requires that the fund manager engages more closely with the fund counsel to articulate the waterfall in a manner that they can actually implement with a degree of automation. Any deviation from the waterfall, as provided in the fund documents could potentially be taken up against the fund manager.
Comments: The advantage for the entrepreneurs raising capital through a PPM is the ability to offer a traditional format meeting generally accepted investment terms and conditions familiar to passive investors. PPM are generally not very attractive to angel investors for the following reasons: 1) angel investors prefer a more active role in the venture, 2) angel investors would ideally prefer to have the opportunity to influence the business plan, 3) angel investors need prospect of negotiating the valuation and share purchase price of the venture. Furthermore, the PPM approach limits the entrepreneur’s ability to change content of the prospectus in response to changing market or business conditions.
WRAPPER (FOR OFFSHORE FUND)
A wrapper is a short supplement that is attached to the PPM of a domestic fund (in case of ‘unified structure’) to help achieve compliance with the requirements for private placement of the securities / interests of an offshore fund to investors in jurisdictions outside India. The use of a wrapper is popular in unified investment structures as the risks of the onshore fund are inherent in the shares/ LP interests issued to investors to the offshore fund.[7]
CONSTITUTION DOCUMENT (FOR OFFSHORE FUND)
A constitution is the charter document of an offshore fund in certain jurisdictions. It is a binding contract between the company (i.e. the fund), the directors of the company and the shareholders (i.e. the investors) of the company. [8]
SUBSCRIPTION AGREEMENT (FOR OFFSHORE FUND)
The Subscription Agreement sets forth the terms and conditions of on which an investor will subscribe to the securities / interests. It is the “sales contract” for purchasing the securities (opposite of a public offering). The subscription agreement sets out the investor’s capital commitment to the fund and also records the representations and warranties made by the investor to the fund. This includes the representation that the investor is qualified under law to make the investment in the fund. In case, the fund is set up in the format of a limited partnership, this document would be in the format of a limited partnership agreement (with the ‘general partner’ holding the management interests). [9]
ADVISORY AGREEMENT (FOR OFFSHORE FUND)
The board of an offshore fund may delegate its investment management / advisory responsibilities to a separate entity known as the Investment Advisor or the Investment Manager. The Investment Advisory Agreement contains the general terms under which such investment advisor render advise in respect of the transactions for the fund’s board. Sometimes, the investment advisor / manager of an offshore fund enters into a ‘sub-advisory agreement’ with an on-the-ground investment advisory entity (the sub-advisor). The sub-advisory agreement typically provides that the sub-advisor will provide non-binding investment advice to the investment advisor of the offshore fund for remuneration. [10]
INDENTURE OF TRUST (FOR ONSHORE FUND)[11]
The Indenture of Trust is an instrument that is executed between a settlor and a trustee whereby the settlor conveys an initial settlement to the trustee towards creating the assets of the fund. This instrument also provides the various functions and responsibilities to be discharged by the appointed trustee.[12]
INVESTMENT MANAGEMENT AGREEMENT (FOR ONSHORE FUND) The Investment Management Agreement is entered into by and between the trustee and the investment manager. Under this Agreement, the trustee appoints the investment manager and delegates all its management powers in respect of the fund (except for certain retained powers that are identified in the Indenture of Trust) to the investment manager. [13]
CONTRIBUTION AGREEMENT (FOR ONSHORE FUND)
The Contribution Agreement is to be entered into by and between each contributor (i.e. investor), the trustee and the investment manager and, as the context may require. The Contribution Agreement records the terms on which an investor participates in a fund. This includes aspects relating to computation of beneficial interest, distribution mechanism, list of expenses to be borne by the fund, powers of the investment committee, etc. A careful structuring of this document is required so that the manager/ trustee retain the power to make such amendments to the agreement as would not amend the commercial understandings with the contributor. [14]
INVESTOR SIDE LETTERS It is not uncommon for some investors to ask for specific arrangements with respect to their participation in the fund. These arrangements are recorded in a separate document known as the side letter that is executed by a specific investor, the fund and the investment manager. Typically, investors seek differential arrangements with respect to management fee, distribution mechanics, participation in investment committees, investor giveback, etc. An investor may also insist on including a ‘most favoured nations’ (MFN) clause to prevent any other investor being placed in a better position than itself. An issue to be considered is the enforceability of such side letters unless it is an amendment to the main contribution agreement itself.[15]
AGREEMENTS WITH SERVICE PROVIDER
Sometimes, investment managers may enter into agreements with placement agents, distributor and other service providers with a view to efficiently market the interests of the fund. These services are offered for a consideration which may be linked to the commitments attributable to the efforts of the placement agent / distributor.[16]
SCHEME MEMORANDUM[17]
AIF may launch various schemes subject to filing of a Scheme Memorandum with SEBI. Such scheme memorandum shall contain all material information about the investments proposed under such scheme. The memorandum is required to be filed with SEBI at least 10 working days prior to launch of the scheme. Please note that Scheme fees shall not be applicable to schemes launched by Angel Funds. SEBI may communicate its comments, if any, to the applicant prior to launch of the Scheme and the applicant shall incorporate the comments in the Scheme Memorandum prior to launch of scheme. No scheme of the Angel Fund shall have more than forty nine investors.
TRUST DEED
If the Angel Fund is set up as a Trust, A Trust Deed may be required to be signed for this purpose. The most common structure for setting up Angel Funds is ‘trust’ because of tax efficiency.
MEMBERSHIP FORM / UNDERTAKING
This is a private document/agreement which is signed by the Angel Fund and any new angel investor who wants to become a member to an Angel Fund. The document may lay down membership requirements, process for membership qualification, member’s responsibilities. etc. A sample undertaking can be seen here.
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[2] Paragraph 2(a)(i)of the SEBI Circular CIR/IMD/DF/14/2014.
[3] Regulation 11(2) AIF Regulations
[4] Regulation 2(1)(c) of the AIF Regulations
[5] Paragraph 2(b)(i) of the SEBI Circular CIR/IMD/DF/14/2014
[6] Paragraph 2(b)(iv)(a) of the SEBI Circular CIR/IMD/DF/14/2014
[7] Supra Note 1
[8] Ibid.
[9] Ibid.
[10] Ibid.
[11] Supra Note 1
[12] The Indenture of Trust is an important instrument from an Indian income-tax perspective since the formula for computing beneficial interest is specified. The formula for computing beneficial interest is required to establish the determinate nature of the trust and consequently for the trust to be treated as a pass-through entity for tax purposes.
[13] Supra Note 1
[14] Ibid.
[15] Ibid.
[16] Supra Note 1
[17] Amended AIF Regulations, Reg. 19E, available at http://www.sebi.gov.in/cms/sebi_data/boardmeeting/1373446721941-a.pdf