Sebi Guidelines for Angel Funding: Why Should Angels Stay Put in a Company For 3 Years?

angelMarket regulator Sebi finally came out with guidelines for Angel investors in India recently. Essentially, Angel funds can now become Category I Alternative Investment Funds (AIFs), an investment class that allows them certain  tax benefits. While the good part is that the government has made an attempt to understand angel investing and work out a decent framework there are some critical flaws in it.

While most angels agree that the attempt to create this asset class that encourages individuals to join hands and invest is encouraging, there are a few issues that really needs attention. “While some of the recommendations are reasonable, others defeat the purpose,” says Karthik Reddy of Blume Ventures.

The Onerous 3 Year Stay Put Clause

The most contentious, of all the clauses is the 3 year rule that says investors must stay put in a company for a minimum of 3 years.

The clause rules out investment opportunities in a whole lot of companies, says Reddy who also notes that a clause which mandates approval from all members for an investment is a “disaster.” “We can’t even get consensus all the time in a 5 member Investment Committee,” he said. Angel networks in India are already under fire from entrepreneurs for being slow.

Padmaja Ruparel, the President of the Indian Angel Network (IAN), agrees that the three year clause is a bit onerous. “If I as an investor can exit in 15 months, why will you want me to hold on for 3 years?” she asks. While she agrees with the intent, it goes against the premise of Angel investing, she contends.

Ruparel is in talks with the Sebi, which could re-look at the clause. “At IAN, we have had companies that we have exited in 15 months and made 6 times the capital,” she said.

Different companies grow differently and it doesn’t make sense to keep a standard 3 year exit restriction on them. Many angels often cash out during the Series A round. This money usually comes back into the system in the form of newer investments. This clause prevents them from quick exits.

Other Issues

“Compared the the ease at which US investors invest into their startups, this is yet very burdensome. We still haven’t made it easy for overseas investors to angel investor individual angels to organize themselves better,” said Reddy.

Sebi has also proposed that Angel Funds must not have more than 49 investors to ensure that investment in an investee company is not akin to a public issue. Current angel networks are already larger than 49 members. For instance, the Mumbai Angels has more than 150 members.”Retrofitting a large angel network to this model may be a challenge,” Reddy said. However, he is in favor of smaller networks that are more specialized by geography or sector.

Nikhil Kumar, the Co-Founder  of eLagaan says that the new guidelines have brought in more structure to Angel funding. “But it also brings in more compliance requirements,” he said. Funds now have to submit detailed valuation methodology and other such details of running the fund.

If one of the investors in the Fund is a family member of the startup, the fund cannot invest in the company. However, nothing prevents him from investing in his individual capacity. For now, the new guidelines don’t really affect Individual angels and startup founders.

Other interesting aspects of the Sebi guidelines have been covered in this video below.