venture capital funds: PE houses, VCs can no longer stretch their fund’s life to avoid fire sale
The Indian capital markets regulator has made it unambiguously clear that funds have to close and liquidate within the specified period even if a predominant number of investors who have contributed to a fund pool give their consent to extend the tenure of the fund.
May Knock on Sebi Door
Fund managers often postponed exits and closure due to a slew of factors like a bad market, litigations, non-performance of portfolio companies, a dip in property prices, or delays in IPOs by investee companies, particularly startups. Claiming to fulfil their fiduciary role, the managers kept funds alive for longer periods to fetch a better deal for investors.
However, the regulatory stance, spelt out in an October 31 order of the Securities & Exchange Board of India (Sebi), has shaken the fund industry which till now was under the impression that the regulator’s silence on the subject along with investors’ concurrence allowed them to extend the term of a fund.
Industry officials fear that many funds could now be driven to undertake distress sale of assets to fall in line with Sebi’s observation that “keeping a fund alive until a profitable exit is achieved would set a wrong precedent and would have an adverse impact on the objective and development of the securities market”.
Such alternative investment funds (AIFs) typically have a life of 7 to 10 years. Sebi AIF Regulations stipulate that the tenure of a closed-ended AIF can only be extended up to a maximum two years with the approval of two-thirds of the investors by value.
“Interestingly, the erstwhile Sebi VCF Regulations did not contain such a formal cap and left it to investment manager and investors to contractually determine the same in fund documents including the placement memorandum. However, the Sebi order which has been issued in the context of erstwhile VCF Regulations has stated that once the period of maturity has been fixed in the placement memorandum, it is not open for the trustee or the investment manager to further extend the same even with the consent of the investors. This does not augur well for numerous VCFs still governed under old Sebi VCF regime as well as AIFs governed under the Sebi AIF regime (which may also take a cue from this Sebi order), who are exceeding their original term and permitted extensions, due to several practical challenges arising out of underlying litigations, illiquid investments, Covid-impacted portfolio entities, etc,” said said Tejesh Chitlangi, Senior Partner at IC Universal Legal, who feels Sebi has to come out with a flexible regulatory policy to take care of genuine cases.
According to Richie Sancheti, founder of the law firm Richie Sancheti Associates, “A view from the regulator seems to be that investor approvals cannot be relied upon to extend the term of a fund to perpetuity, which otherwise would render redundant some of the fundamental tenets of the regulations. The regulator’s seriousness can be gauged from a recent circular issued in context of AIFs and the minutes summarised in the board memorandum proposing the amendments. On the one hand, the industry will need to ensure tighter alignment between the fund term and the asset class targeted, as unduly longer terms may not be acceptable to non-institutional investors. On the other hand, in addition to selling portfolio to other GPs, a fund sponsor may consider continuation vehicles working with their current investor base, or LP secondaries to add to the liquidity dynamics for the fund.”
A GP, or a general partner, is a PE firm while investors in the fund are LPs or limited partners.
Since in many cases Sebi did not respond to applications from funds for tenure extension, the managers felt the regulator was not against the proposal. The recent order has unsettled their plans.
Multiple sources in the fund industry said that the issue would be taken up with Sebi which has not factored in the economic hardships faced by many funds and investee companies.
“Also, since Sebi in its order (relating to a realty fund UIVCF) has not only debarred the investment manager, trustees but also their directors for not securing timely portfolio exits within the original term and allowing unauthorised extensions, it may raise concerns for the non-executive and independent directors on the boards of non-compliant managers and trustees,” said Chitlangi.