SEBI AIF categories explained: Category I, II and III for beginners

An Alternative Investment Fund (AIF) is a privately pooled investment vehicle set up in India that collects money from investors and invests it under a defined policy. Before acting as an AIF, the fund needs a certificate of registration from SEBI (Reg 3(1)). When it registers, it chooses one of three categories, and that choice decides most of the rules it will live with.

The three categories in one line each

• Category I invests in areas the government or regulators want to encourage, such as start-ups, early-stage and social ventures, SMEs and infrastructure.
• Category II is anything that is not Category I or III and does not use leverage beyond what the Regulations allow. Private equity and debt funds usually sit here.
• Category III uses diverse or complex trading strategies and may use leverage, including through derivatives.

(Reg 3(4))

Inside Category I: the sub-categories

Category I is a family. Each sub-category has its own investment condition, usually that at least 75% of investable funds go into its target area:

• Venture capital funds: unlisted equity of venture capital undertakings, or companies listed or proposed to be listed on an SME exchange (Reg 16(2)(a)).
• SME funds: unlisted securities or partnership interest of venture capital undertakings or SMEs, or SME-exchange companies (Reg 16(3)(a)).
• Social impact funds: social ventures or securities of social enterprises (Reg 16(4)(a)). They may accept grants of at least ₹10 lakh (no minimum for accredited investors), and no profit can accrue to the giver (Reg 16(4)(b)).
• Infrastructure funds: companies or SPVs that develop, operate or manage infrastructure projects (Reg 16(5)(a)).
• Angel funds and special situation funds, each with a chapter of its own.

Category II: no leverage for investing

A Category II fund invests primarily in unlisted investee companies or in listed debt rated 'A' or below (Explanation to Reg 17(a)). It cannot borrow to make investments. It may borrow only for temporary funding and day-to-day needs: for up to 30 days, on up to four occasions a year, and up to 10% of investable funds (Reg 17(c)). Category I has the same borrowing limits (Reg 16(1)(c)).

Category III: complex strategies, with guard-rails

A Category III fund may invest in listed or unlisted securities, derivatives, units of other AIFs, or complex or structured products (Reg 18(a)). It may use leverage, but only with investors' consent and within the maximum limit SEBI specifies, and it must disclose its overall leverage (Reg 18(c)).

How much can go into one company?

Category I and II funds can put up to 25% of investable funds into one investee company, directly or through other AIFs; large value funds for accredited investors can go up to 50%. Category III can put up to 10%, or 20% for a large value fund (Reg 15(1)(c), (d)).

Example. A Category II scheme with ₹200 crore of investable funds can invest at most ₹50 crore in one company. A Category III scheme of the same size can invest at most ₹20 crore.

The entry rules every AIF shares

• Corpus of at least ₹20 crore per scheme, or ₹5 crore for a social impact fund (Reg 10(b)).
• Minimum investment of ₹1 crore per investor, ₹25 lakh for employees or directors of the AIF or its Manager, and no minimum for accredited investors (Reg 10(c)).
• A continuing interest from the Manager or Sponsor: the lower of 2.5% of corpus or ₹5 crore, or for Category III the lower of 5% or ₹10 crore, as an investment and not through a fee waiver (Reg 10(d)).
• No more than 1,000 investors per scheme, with accredited investors not counted (Reg 10(f)).
• Money raised only by private placement (Reg 10(g)).

Key takeaways

• Pick the category that matches what the fund will actually do. The category decides the investment and borrowing rules.
• Inside Category I, check the 75% condition for your sub-category from the start.
• Use the SEBI AIF Setup Navigator to test your plan, and the SEBI AIF calculators for corpus, continuing interest, concentration and borrowing.