SEBI’s Co-investment Framework for AIFs: Analysing the Proposed Reforms and Path Forward

Yashika Lakhotia and  Yarabham Akshit Reddy*

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INTRODUCTION

Under the traditional Alternative Investment Funds (‘AIFs’) Model, investors commit their capital to the pooled fund without any knowledge or visibility of investments made into specific portfolio companies. These investments are based solely on AIF manager’s investment thesis and strategies. In contrast, co-investments are parallel investments alongside AIFs, where investors are given an opportunity to investment directly into the specific portfolio company, on similar terms or conditions as the AIF, outside the traditional pool structure. These multi-purpose instruments not only assist the sponsors in efficient capital management, but also enables the investors to have direct access to specific deals and invest on a low-cost basis.

In pursuit of improving regulatory flexibility and reducing compliance burdens, the Securities and Exchange Board of India ('SEBI’) introduced a new consultation paper (‘Paper’) on 9 May 2025, proposing a dedicated co-investment framework. This framework permits AIFs to offer co-investment opportunities through separate Co-Investment Vehicles (‘CIVs’) operating alongside the main fund in unlisted securities. Further, it also proposes removing the existing prohibition on Investment Manager (‘IM’) of AIFs from providing advisory services in listed securities.

Through this post, the authors aim to critically evaluate the challenges existing in the current regulatory framework and the rationale behind SEBI's proposed reforms. They further analyse SEBI's proposals, identify its potential shortcomings and recommend solutions to further strengthen the framework.

REGULATORY SHIFT: BACKGROUND AND THE PROPOSED CHANGES

Earlier, Co-investments were made under the SEBI (Portfolio Managers) Regulations, 2020, (‘PM Regulations’) which restricted the investment up to 25% of the managed assets of the client. Additionally, the investors were allowed to exit these investments before the expiry of the term, resulting in early withdrawals. This flexibility led to the non-alignment of interests of the investors of AIF and the co-investors. Recognizing these challenges, the Ease of Doing Business Working Group (‘EoBD WG’) reviewed the existing framework, identified key issues and proposed changes. These recommendations laid the groundwork for a better framework to be notified by SEBI. Building on these recommendations, SEBI released the paper inviting public comments for its proposed framework.

The paper proposes separate CIV schemes for each co-investment under the AIF, maintaining the pro-rata rights of the investors by allowing the CIV to invest in a single investee company and relaxing the investment concentration norms. CIV was proposed to be exempt from investment diversification norms and minimum tenure restrictions applicable to AIFs. A co-terminus policy is also proposed where the terms of AIF and CIV are the same, along with the exit terms, to ensure that more favourable investment terms are not provided to the co-investors than the AIF investors. Further, the current framework restricted the advisory services offered by the Managers of the AIF for reasons of conflict of interest. The consultation paper seeks to allow advisory services by Managers of AIF on listed and unlisted securities, irrespective of whether the AIF has invested in the same or not, as there may not be any conflicts of interest between the Manager and the investors of AIF.

ANALYSING THE SEBI’S PROPOSALS:

The proposed changes suffer from various drawbacks and criticisms on a few important aspects of co-investment.

Firstly, the CIVs, fall in the same category as the AIF – either Category I or Category II, and can invest only in unlisted securities of the investee company of AIF. While an AIF has to ‘primarily invest’ in unlisted securities, this does not bar them from investing in listed securities. Completely barring co-investments in listed securities reduces investment options for co-investors for investing in those listed securities which the AIF has already invested/ seeks to invest in.

A counter argument to this point would be that listed securities can be traded through stock exchanges. However, in such a circumstance, the buying and selling of the securities would be dependent on prevailing market rates, which may not always be as favourable to the co-investors as the terms secured by the AIFs. Given that AIFs can invest in listed securities only to a limited extent, they often seek preferential access to select market issuances through negotiated deals Additionally, AIFs are likely to show increased interest in listed debt securities, particularly after SEBI has relaxed the earlier mandate requiring them to “primarily invest in unlisted securities”. In this context, allowing co-investments in both listed and unlisted securities can provide co-investors with more stable and secure deal terms, especially when such investments are structured with a lock-in period and co-terminus exit terms aligned with that of AIF.

Secondly, the paper proposes to file the Shelf Private Placement Memorandum (‘PPM’) at the time of registering the AIF.  PPM serves as an information memorandum of AIFs which discloses key details such as investment strategies, risks involved, fee structure and investor rights, enabling informed decision-making. The reasoning behind this is to allow the prospective investors to inspect the co-investment policy prior to investing in AIF, providing them with the opportunity to make an informed decision about the quantum of investment and the possibility of investing through CIV.

However, this would impose an additional burden on the IM of the AIF to comply with the shelf PPM requirements which include parameters of co-investment rights offered and co-investment policy alongside fulfilling CIV-related compliances and completing the registration process of AIF. In practice, the opportunity to co-invest may not arise until the AIF has made certain investments and the IM identifies a suitable co-investment opportunity. Further, each investment may have its own conditions, timelines and returns. In such a scenario, filing the shelf PPM at the time of AIF registration may serve little practical purpose where details of co-investment cannot be specified in advance. Moreover, the paper fails to address situations where IM does not file Shelf PPM at the time of AIF Registration but seeks to offer co-investment at a later stage when they actually materialize.

Thirdly, the paper proposes that the tenure of a CIV shall be co-terminus with that of the main AIF. The objective behind this mandate is to ensure that the AIF manager does not secure co-investors more favourable terms of investment, than the main AIF, and to restrict early exits that could compromise the interests of AIF investors.

However, this requirement could be detrimental to the rights and investment strategies of co-investors in certain scenarios. It is not always necessary that co-investors and AIF deploy capital into a portfolio company simultaneously. Frequently, companies undergo multiple rounds of funding, with co-investors often brought in at later stages. Unlike AIFs, which have fixed tenure and are required to exit within that period, co-investors have a greater incentive to stay invested in a company long after the AIF exits    , especially in startups and growing companies which show a significant growth potential. In such cases, imposing a co-terminus requirement may lead to premature exits and suboptimal investment outcomes, limiting the positive upsides for co-investors.

AIF Regulations already include safeguards to balance flexibility with investor protections. Regulation 20(22) of AIF Regulations mandates that all the investors must be treated Pari-Passu in all aspects which ensures equality in all the economic and other rights of AIF investors. However, proviso to regulation 20(22) allows IMs to provide differential rights to select individuals subject to the conditions that: (a) the same shall not have any adverse impact on economic rights and other rights of other AIF investors; and (b) any such rights or eligibility criteria shall be adequately disclosed in the PPM of AIF or its schemes. This built-in flexibility could be extended to CIVs, allowing tailored exit terms where regulatory oversight ensures compliance with the stipulated conditions and disclosure requirements in PPMs allowing prospective investors to understand their existence.

Nonetheless, restricting this flexibility to CIVs may however prompt the co-investors to revert back to the PM Regulations route, where they can negotiate their exit timelines contractually as SEBI has permitted the PM regulations to co-exist alongside the CIV framework. However over-reliance on this parallel route may lead to fragmented cap tables and direct ownership structures, which increases documentation complexity and regulatory burdens for the investee company and IMs. On the contrary, CIVs would provide a cleaner structure by pooling co-investors under one single entity and providing a more streamlined mechanism for granting differential rights. Any such rights which adversely impact the other investors would be immediately terminated before launching a CIV scheme, striking a balance between flexibility and fairness without compromising the interests of AIFs.

Lastly, the paper proposes to remove the prohibition on IM of AIFs from providing advisory services to other investors in listed securities irrespective of whether AIF has invested in such securities or not. This is a logical and progressive step, as listed securities are publicly traded and are available at market price. There is minimal scope for preferential treatment, insider information or price manipulation. Allowing IMs to offer advisory services in these securities could benefit investors by leveraging managers' access to specific deals and market insights, facilitating informed decision-making by the investors.

Previously, SEBI had amended the AIF Regulations to introduce Regulation 20(15), which prohibited AIF managers from providing advisory services to any party other than clients of Co-Investment Portfolio Managers (‘CPMs’). This restriction even extended to B2B arrangements, where AIF managers were able to advise offshore fund managers or foreign institutional investors without seeking registration. This prohibition significantly curtailed the global competitiveness and operational flexibility of AIF fund managers.

While the original intent behind Regulation 20(15) is to prevent conflicts of interest and ensure fair treatment of AIF investors, it needs reconsideration. By expanding the scope to thinly traded and unlisted securities, it has the potential to unlock greater investment opportunities for companies in need of capital, especially in private and semi-liquid markets, fostering innovation and economic growth. However, it raises significant concerns that other investors would be given preferential treatment and secure more favourable terms at the expense of AIF investors.

STRENGTHENING THE CIV FRAMEWORK: RECOMMENDATIONS AND SOLUTIONS

To strengthen these forward-thinking proposals, it is essential to address the highlighted shortcomings and challenges. The following specific recommendations can help achieve this.

Firstly, the authors propose that CIVs be directed to 'primarily invest' in unlisted securities, similar as to the investments allowed by Category I and Category II AIFs. This would ensure that the CIVs are not barred completely from investing in listed securities, allowing investors to choose their choice of investment.

Instead of mandating the filing of the Shelf PPM at the time of registration of AIF, SEBI could allow the managers to file a co-investment term sheet with certain terms and conditions within 21 days for approval from the time a co-investment opportunity arises. A similar approach was taken by the IFSCA consultation paper on the Co-investment framework ('IFSCA paper') which reduces compliance burden and improve operational flexibility.

Secondly, to address the issue of co-terminus tenure of the CIV and AIF, SEBI should consider allowing flexibility in allowing the term of co-investments to extend beyond the tenure of the main AIF, subject to adequate disclosures. This flexibility should be made conditional upon disclosure of any differential rights offered in terms of extended tenures and measures taken to mitigate conflict of interests. Such disclosures must be outlined in the PPMs submitted to SEBI prior to the launch of CIV schemes, ensuring compliance with Regulation 21 of the AIF Regulations. Additionally, AIF managers should establish clear and transparent co-investment policies in accordance with Regulation 20,     which would be disclosed to all investors. This would ensure informed decision-making and maintain parity between AIF and co-investor interests.

Finally, on the aspect of the advisory capacity of IM and potential conflict of interest, guidance could be drawn from the IFSCA (Fund Management) Regulations, 2022 (‘FM Regulations’) where the Fund Management Entity (FME) can also provide advisory services under Regulation 80 as part of its portfolio management services. The regulation establishes structural and procedural safeguards to prevent conflict of interests. This includes strict segregation of activities, mandatory disclosure requirements, fair allocation of opportunities and prohibition on misuse of non-public information obtained through AIF activities.

Additionally, the FME should be required to adhere to a Code of Conduct and act in a fiduciary capacity for the best interests of all investors. Any potential conflicts must be fully disclosed to all investors where IM advises on securities in which the AIF has also invested. This would ensure transparency where FMEs do not provide preferential treatment to advisory clients and secure them more favourable deal terms.  Further, advisory services could be restricted to sophisticated investors who possess the necessary financial expertise and risk appetite, who could understand the complex fund strategies and can take exposure to riskier investments. This category includes institutional investors, high-net-worth individuals or AIs who meet minimum portfolio thresholds prescribed by the SEBI’s Accreditation Framework. This ensures alignment with the long-term objectives of the AIF where sophisticated investors could commit serious capital and remain invested for a longer time,  reducing any risks of short-term strategies that may undermine the fund’s goals. This integrated framework under  AIF Regulations would ensure that AIF investors are not disadvantaged by advisory activities.

CONCLUSION

The paper is a welcome move for the AIF industry, providing a regulatory framework to facilitate co-investments as a separate scheme, rather than being governed under the PMS regulations. However, the lacunae present in the paper must be filled before it can come into force as guidelines.

The IFSCA paper and IFSCA (FM) Regulations can be seen as a guiding light for SEBI to mould the co-investment framework. Investor interest must be paramount to ensure that this way of private placement reaps benefits and ensures the growth of both the investors and the investee company. To this end, certain freedoms must be given to co-investors to decide their terms of exit from the CIVs, while IMs should be provided with the discretion to advise on and effectuate co-investment opportunities.

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*The authors are 4th year students at HNLU Raipur.