Accredited Investors as QIB’s - A Gamechanger for Startup Funding

[Owais Khan is a final year law student at Government Law College, Mumbai]

Introduction:

On 21 February, 2025 the Securities and Exchange Board of India (“SEBI”) has released a consultation paper (“paper”) recommending the inclusion of Accredited Investors (“AIs”) within the definition of Qualified Institutional Buyers (“QIBs”) for the limited purpose of investment in Angel Funds (“AFs”).

In light of this paper, the present article deliberates on the investor class of AIs, the rationale behind expansion of the definition of QIBs to accommodate this class, eliminating the cap on the number of investors in AFs and finally on the impact of this recommendation in boosting the startup funding.

Accredited Investors - A new class of Angel Investors:

Angel Investors are those investors who provide capital to the AFs, which is a type of Category I Alternative Investment Funds (“AIFs”) under the ambit of the Venture Capital Funds (“VCF”). They are governed by Regulation 19A of the SEBI (AIF) Regulations 2012. AFs are highly sophisticated funds based on high risk – high return framework, supported by the Angel Investors who are acknowledged in the market regime for their commensurate risk appetite. The major difference between AFs and other AIFs is the need to take mandatory approval of the investors on a deal-to-deal basis in case of AFs.

However, it was discerned that despite being a high-stake game, Angel Investors were onboarded by the AIFs without any diligent risk profiling, mostly relying on the social media profiles and self- declarations of the investors. As a panacea to this regulatory irregularity, SEBI had released an earlier consultation paper which envisioned  that only the AIs, as an investor class shall be allowed to invest in the AFs. The criteria to be classified as an AI was also outlined in the earlier paper, who would be granted a certificate of accreditation by an independent accreditation agency.

The intent behind the same is to create a funnel ensuring only genuine risk bearing investors are allowed to invest in this segment of the AIF.

Expanding the ambit of QIBs:

The AFs raise capital from the Angel Investors to invest in early-stage startups through Private Placement (“PP”). Under Section 42 of the Companies Act 2013, the offer to subscribe to securities by PP is limited to 200 persons. However, the QIBs are excluded from this restriction. At present, the Angel Investors are not included as QIBs.

Thus, with the remodeling, allowing only the AIs to invest in AFs, the paper recommends the inclusion of AIs as QIBs for investing in AFs presently outlined in Regulation 2(1) (ss) of the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 (ICDR Regulations). This would enable the AFs to raise more capital which would surely have a great spillover effect in the overall economy as the AFs would be able to expand their funding to the startups with greater access to the capital provided by the AIs who shall be now excluded from the 200 persons cap.

The eligibility criteria outlined in the earlier paper has made every possible attempt to bring the AIs in consonance with the already existing classes of QIBs. Thus, the paper attempts to navigate a clever tunnel for maintaining the private nature of placement undertaken by the AFs and at the same juncture, allowing them to raise capital from the AIs by their inclusion within the definition of QIBs.

Moving away from the Investor limit in Angel Funds:

At present, there are no restrictions on the number of investors that may be onboarded by the AFs. However, Regulation 19E (2) of the SEBI (AIF) Regulations provide that any scheme launched by AFs shall not have more than 200 Angel Investors.

The continuation of this restriction, post the reclassification of Angel Investors as AI and its inclusion within QIB would result in a gate opened partially, but not free from encumbrances. This would result in a scenario wherein though the AFs are financially apt to support the startup, it may be restrained from doing so owing to this limit in the number of investors not serving the imperative purpose of providing better funding to the startups, rather resulting in the capital being raised by the AFs remaining unutilized.

Also, the rationale behind the cap lies in the high-risk nature of the AFs and to protect the investors from the same. However, the eligibility criteria formulated by SEBI for the AIs gives due credence to the financial strength, resources and sophistication of the AIs satisfying the cushioning nature in case of any losses and allowing only the risk resilient investors to invest in the AFs, with sufficient guardrails in place. Thus, this makes the 200-investor limit cap redundant and antithetical to the inclusion of AIs as QIBs, as there is no cap even on the number of securities allotted to QIBs in a PP.

Hence, the paper recommends eliminating this limit on the number of investors, thereby allowing the AFs to fund the startups with greater capital. This would also result in better channeling of funds from the AIs to the startups, without any regulatory impediment in the investment. The paper further recommends for allowing the KMPs of the AF to invest in the scheme without the minimum investment amount, thereby bringing their skin in the game. 

A harbinger for Seed Funding:

No doubt, a startup is an outcome of sheer entrepreneurial zeal of first-generation entrepreneurs. In the 21st century globalized world, pure intentions and resilience surely meet the destiny for these emerging entrepreneurs via the aid of seed funding.

The seed funding, which is a VCF, mostly undertaken by AFs plays a crucial role in fructifying and crystallizing any novel business idea by supporting the startups right from their genesis. The modus operandi involves investing in startups with high growth potential in exchange for equity stakes in these unlisted startups. The funding is a win-win situation for both, the startup to expand as well as the VCFs to invest. These funds provide managerial expertise to the startups coupled with much needed capital support at a time when it lacks both. The capital provided at this stage plays a very crucial role for important operations like product launch, product development and recruitment. This is the main reason for these investments being highly risk prone. Further, the recent state of commercial affairs is a testimony to the fact that these startups have been successful in yielding high returns to their seed funders post their successful Initial Public Offerings by virtue of Offer for Sale (OFS) or acquisition. The Hyundai IPO, the largest in terms of capital raised till date, was also entirely structured as an OFS. Similar trend was observed in the IPOs of Mamaearth and Firstcry.

The example of the seed funding provided by Accel Venture Capital to Flipkart, serves as one of the many case studies of the role of seed funding in the startup regime of India. As of March 31, 2024, there are 82 AFs registered with SEBI under the AIF Regulations, with a total of INR 7,053 Crore in commitments and INR 3,343 Crore in investments, as provided in the earlier consultation paper.

Thus, the paper is a step in the right direction at the right time to strengthen the rising boom of startups and unicorns in the country. With the inclusion of AIs as QIBs and the removal of the investor cap in AFs scheme, SEBI has explicitly showcased its countenance to support the entrepreneurial spirit to ensure greater capital availability of the startups owing to the manifold positive attributes that a successful startup provides to the economy. This is in consonance with the abolition of Angel Tax by the Central Government.

Critical Analysis:

Regulation 19A (2) of the SEBI (AIF) Regulations, which provide for the eligibility criteria of the Angel Investors also takes into due consideration the experience aspect apart from strong financial strength. The earlier paper outlining the eligibility of AIs is silent on the same. Thus, the author is of the firm view that experience aspect of Angel Investors must mutatis mutandis apply for the AIs.

Further, as the paper recommends the enabling of greater funding by VCFs in these startups, the author is of the firm view that it is high time to reconsider VCFs as promoters, taking into consideration their implicit control and influence over the affairs of the company, and not limiting control on the basis of shareholding pattern.  At present, the promoter definition in Reg. 2(oo) of ICDR Regulations excludes VCFs as promoters.

Conclusion:

If the recommendations are implemented in true spirit, the commercial landscape of the country is surely to experience a dynamic shift. The author believes that the regulator surely deserves appreciation for noticing these statutory impediments creating unnecessary complexities for the startups in raising funds.

Also, providing for a sector wise mandatory investment by the AFs might surely help in the cumulative economic development and to better meet the needs of startups engaged in any futuristic avenues like Artificial Intelligence, Renewable energy, etc.