SEBI’s Angel Fund Overhaul: Boosting Domestic Capital or Reducing Investor Access to Startups?

The Securities and Exchange Board of India (SEBI)’s proposal to regulate angel funds under Alternative Investment Funds (AIFs) and increase investment limit for startups aims to foster growth in India’s entrepreneurial landscape with more stricter scrutiny of these investors. The capital markets watchdog seeks to limit investment to accredited investors who has risk appetite and ability to evaluate investment proposals while also enhancing ease of doing business.

It has also proposed to raise the maximum investment limit by an angel fund to Rs 25 crore from the current Rs 10 crore and the minimum investment limit to be reduced to Rs 10 lakh from Rs 25 lakh at present, the regulator said in its consultation paper. In addition, Sebi recommended reducing the lock-in period from one year to six months to enhance liquidity and flexibility for investors.

These amendments also include capping the number of investors for any single company to 200. According to the regulator, eligible angel investors include family trusts, corporations, and individuals with five years of experience who must be accredited by an external independent agency. It has sought public comments until November 28 before finalizing these rules for angle funds.

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Added Burden or Better Governance?

Industry players view these proposed regulations as “game changer” for Indian startups, especially early-stage ventures which will get more substantial backing from seasoned investors in terms of finances, mentorship, and strategic insights. However, the move may even the investor pool due to its focus on accredited investors.

“Angel funds could face some obstacles because these will now be limited to accredited investors which will limit the number of individual investors. Compliance costs may also get increased funds ensure all investors meet the Sebi’s criteria. And the addition of third party verification for each accredited investor could add further cost,” Sushanto Mitra, founder and CEO of Lead Angels told Outlook Business.

Some provisions will also increase the cost of operating an angel fund which will indirectly affect the viability of funds, he said, while calling it a complex task to manage compliance aspects as well as keeping the fund attractive to investors. Currently, there are 82 angel funds registered with Sebi, collectively managing over Rs 7,000 crore.

Investors added that these regulations will enhance governance, maintain transparency and accountability by focusing on accredited investors who bring more structured approach to investing due to their experience in financial sector. “It will help reduce speculative actions and create a safer environment for both startups and investors,” Mitra added.

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“In other markets, tiered minimums based on the company’s maturity level have been shown to encourage disciplined investing, with higher minimums applied to later-stage rounds to match the capital requirements of more established startups. Introducing similar flexibility could improve governance in India’s angel investing space,” said Anirudh A Damani, managing partner at Artha Venture Fund.

He stated that simplifying India’s accreditation process would encourage participation from qualified investors, making it easier for angel funds to attract the right level of domestic and global capital to support startups across their journey.

Will It Give Push to Domestic Capital?

India has a robust startup ecosystem with around 1.5 lakh DPIIT-registered ventures as of August 2023. Supportive government policies including Startup India scheme and Rs 10,000 crore Sidbi Fund of Funds are providing much-needed support to this ecosystem.

This success story hides a significant weakness, that is, low share of domestic capital in funding Indian startups. Some media reports stated that nearly 15% of the capital invested in Indian startups came from domestic sources in 2023, and the rest came from foreign investors.

This highlights the need for more domestic capital in India as Prime Minister Narendra Modi encourages the country to become self-reliant (Atmanirbhar). Hence, the abolition of angel tax in the 2024 Union Budget and Sebi’s bid for regulating angel funds are expected to attract more domestic investors in the startup ecosystem.

“With clearer guidelines and more confidence in the system, we expect domestic investors to become more active. This could reduce the heavy reliance on foreign funding and, in turn, encourage a greater flow of local capital into India’s startup ecosystem,” said Heena Arora Agarwal, Founding Managing Partner, Fundvice.

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Startup founders also stated that Sebi’s initiative to expand the pool of eligible investors opens the door to significant domestic capital that has traditionally remained on the sidelines.

“Access to domestic investors, who may also have strategic interests in the growth of homegrown industries, strengthens early-stage funding, fostering deeper engagement from investors who are more likely to be patient capital,” Karan Khetarpal, Designated Partner, Wavelength Partners and CEO of IEComm told us.    

The proposed regulations by Sebi are designed to make angel funds more attractive and easier to manage with transparency in the Indian startup ecosystem. With this, India could also see more domestic capital flow into the early stage startups.