Angel Investment Finally Got Some Repair Done
Just 350 – Yes, that’s what approximately total number of angels world’s third largest start-up ecosystem - India, has got. The US, the world’s largest, has around 300,000 angels and around 400 active angel groups. To even think of aiming for that sort of robustness, we categorically need not just more angels but higher flexibility in their ability to raise funds, invest in various stages for portfolio and geographical diversity, and less restriction in carving their exit strategies. The recent changes in the angel fund regulations can be the inflection point for bringing that robustness.
Securities and Exchange Board of India (SEBI) in March 2015 constituted a standing committee called Alternative Investment Policy Advisory Committee (AIPAC) steered by Infosys co-founder, Narayana Murthy, to advice the market regulator on how to augment the further development of the alternative investments and start-up ecosystem in India. This included the Alternative Investment Funds (AIF) category I that also houses angel and venture capital funds but exclude funds like private equity, debt, hedge, and fund of funds.
Low Deal Size, High Volume
Out of the five amendments announced by SEBI in November last year, the two most impactful of them have been first, allowing investments in start-ups incorporated within five years and not three years. This will trigger more investments to happen in companies that need capital after three years of bootstrapping.
“SEBI wanted to keep it to three years. Our experience is, in general most investors often find it difficult to invest Rs 25 lakh over a period of three years as they may not come across an investment opportunity that interest them,” says Saurabh Srivastava, Chairman, Indian Angel Network (IAN). Srivastava is among the 24-member AIPAC.
The second amendment of immense significance is reducing the lower limit of investments by angel funds from Rs 50 lakhs to Rs 25 lakhs. This will bring under the ambit all the businesses at the idea stage looking for some support to reach the proof-of-concept stage and validate it.
Among the few SEBI registered angel funds - Mumbai-based Contrarian Drishti Partners saw an upswing in the number of start-up applications ever since government defined start-ups earlier last year as entities registered within five years. However, the fund had to turn them away because SEBI doesn’t allow angel funds to invest in companies registered beyond three years. The fund is now not just hopeful of tapping startups which have demonstrated early scale but also is looking at efficient and faster allocation of its fund with less than Rs 25 mlakh investment opportunities.
“Since now we can look at start-ups that need less than Rs 50 lakhs, we are aiming to allocate our entire fund corpus of around $6 million by December 2017 from an earlier target of December 2018,” says Somak Ghosh, Managing Partner, Contrarian Drishti Partners. Ghosh maintains that it will mitigate investors’ risk that was earlier associated with minimum Rs 50 lakhs investment and will boost entrepreneurship by bringing more capital for disposal in early stage mstart-ups. The fund started investing in January 2015 from its first fund, Contrarian Vriddhi Fund-I, and has allocated 40 per cent of it in seven deals.
Switching Over as Fund
The amendments, however, regulate angel funds, not angel networks which are not pooled investment vehicles like funds. The idea, hence, is to encourage such networks including IAN, and Mumbai Angels to convert into angel funds and reap benefits of these amendments.
“IAN is looking to convert to an angel fund. I think other angel networks will also look at converting. SEBI doesn’t regulate angel networks, so one of the reasons for these amendments is largely to help angel networks who are willing to convert to a fund structure,” says Srivastava. India’s largest angel network, IAN has more than 400 angel members and has invested in over 100 start-ups.
The other amendments includes, angel funds can have participation from up to 200 investors in a scheme instead of 49, reduced lock-in period in an invested company from three years to one year that helps next round of investors in a start-up buy out current investor’s stake, and allowing up to 25 per cent of their corpus for investments outside India just like venture capital funds.
Regulations for retail or individual investors, however, have remained unchanged that includes having Rs 2 crore as minimum net worth and significant experience in early-stage deals or have been a serial entrepreneur etc. This is critical as a filter to avoid such investors, first, invest in start-ups, and second, minimize any risk to their return on capital invested.
“This will help in the appropriate selling of financial products to appropriate investors. Otherwise, there will be regulatory challenges, similar to insurance sector where a lot of misselling happens,” asserts Ghosh adding, that, “Countries like the US, Singapore, and the UK have qualified investor category for investors to have a certain level of sophistication in terms of understanding risk.”
The impact of the changes made must be visible in next two-quarters, at least in deal volume, but how much of that will actually occur amidst the slowdown, though there is an uptick in it, will give a sense of the overall impact of SEBI’s move.