Investor Subscription and Disclosure: The Subscription Agreement and Private Placement Memorandum

This is Part Two of a four-part series of short notes covering Chapter 13. This part focuses on the legal instruments that formalise an investor's entry into the fund and the comprehensive disclosure document (PPM) that forms the basis of the investment paradigm.

13.4 The Subscription (Investor Contribution) Agreement

The Subscription Agreement (often referred to as the Contribution Agreement for onshore funds) is the definitive contract that records the specific terms and conditions under which an investor commits capital to the AIF.

Core Functions of the Agreement

• Capital Commitment: It sets out the exact amount of capital an investor has promised to provide to the fund.
• Legal Qualification: It records the representations and warranties made by the investors regarding their legal qualification to make the investment.
• Operational Rules: It documents the fund's distribution mechanism, the list of expenses to be borne by the fund, and the powers vested in the Investment Committee (IC).

Onshore vs. Offshore Terminology

The terminology for this document varies based on the fund's domicile:

• Contribution Agreement: Used for Onshore Funds (domiciled in India).
• Subscription Agreement: Used for Offshore Funds.

Key Provisions and Compliance

• Investor Protection: The agreement contains specific representations and warranties that protect the fund from legal discrepancies related to the investor's source of funds or eligibility.
• Dematerialisation: AIFs are required to issue units in dematerialised mode only. The agreement specifies that investors will receive periodical unit statements from the depository, ensuring transparency in holdings and transactions.

13.5 Private Placement Memorandum (PPM)

The Private Placement Memorandum (PPM) is the primary offer document issued by the sponsor or manager to prospective investors. It is the most critical disclosure document, as it outlines the investment thesis and summarizes the key terms of the fund.

Structure of the PPM (Section A: Minimum Disclosures)

SEBI prescribes a standardized template for the PPM, which typically includes the following 15 sections to ensure transparency:

1. Executive Summary: Overview of the fund and its manager.
2. Investment Outlook: Macro-economic and industry-specific factors relevant to the strategy.
3. Investment Objective and Strategy: Breakdown of sectors, geographies, and the flow chart of the investment process.
4. Fund Structure: A diagrammatic representation of all key constituents (Sponsor, Trustee, Manager, Custodian).
5. Governance Structure: Details on the investment team, valuation committee, and advisory board.
6. Track Record of Manager: Tabular data including fund size, number of investments, and performance metrics like Gross IRR, Gross MOIC, DPI, RVPI, and TVPI.
7. Principal Terms: Detailed list of commercial and legal terms.
8. Portfolio Valuation Principles: The frequency and principles used for valuing portfolio companies (e.g., IPEV Guidelines).
9. Conflicts of Interest: Potential sources of conflict at the level of the manager, sponsor, or service providers.
10. Legal, Regulatory, and Tax Considerations: Relevant extracts of SEBI regulations, FEMA, and tax laws like Section 115UB of the Income Tax Act.
11. Illustration of Fees and Expenses: A tabular format showing how contributions are deployed and the impact of charges.
12. Distribution Waterfall: Scenarios depicting payouts (loss, hurdle rate met, profit in excess).
13. Disciplinary History: Background of the Sponsor, Manager, and Trustees.
14. Glossary: Explanation of industry parlance.

PPM Section B: Additional Disclosures

This section accommodates any additional disclosures the AIF chooses to make over and above the minimum regulatory requirements.

13.6 PPM Audit and Material Changes

To maintain high standards of governance, SEBI mandates regular oversight of the PPM's contents and any subsequent changes.

The Annual PPM Audit

• Requirement: All AIFs must have their books and PPM terms audited annually by a qualified Chartered Accountant (CA) or Company Secretary (CS).
• Timeline: The audit findings and any corrective steps must be communicated to the Trustee, the Board, and SEBI within 6 months from the end of the financial year.
• Exceptions: Angel funds and schemes where each investor commits a minimum of INR 70 crore (or USD 10 million) and provides a waiver are exempt from this audit requirement.

Dealing with Material Changes

A "material change" is any update to the PPM that could alter an investor’s decision to remain in the fund.

• Examples: Change in sponsor or manager, change in control, or modifications to the fee structure or hurdle rate that adversely affect investors.
• Compulsory Exit Option: If a material change is made, the AIF must provide a compulsory exit option to dissenting unit holders.

Key Takeaways

• The Subscription/Contribution Agreement is the individual contract that legally binds the investor to their capital commitment.
• The PPM is the comprehensive "rulebook" of the fund, containing 15 mandatory sections ranging from strategy to disciplinary history.
• PPM Audits are essential for verifying that management fees, distributions, and investment strategies align with the original offer.
• Material Changes in the fund's attributes trigger a regulatory requirement to allow investors to exit if they disagree with the changes.

Important Terms to Know

• Gross MOIC (Multiple on Invested Capital): A metric measuring the total value created by a fund relative to the capital invested.
• DPI (Distributed to Paid-in): A realization multiple measuring the capital returned to investors compared to the capital they provided.
• RVPI (Residual Value to Paid-in): A metric measuring the remaining value of the fund's unrealized investments relative to capital provided.
• TVPI (Total Value to Paid-in): The aggregate of DPI and RVPI, representing the total "net multiple" of the fund.
• Wrapper: A supplement attached to the PPM to ensure compliance for private placement in offshore jurisdictions.
• Side Letter: A negotiated agreement between the manager and a specific investor for differential terms (e.g., lower fees), which must be regularized through a Most Favoured Nation (MFN) clause.

End of Part Two. Part Three will cover Support Services Agreements, including those with Merchant Bankers and Custodians, and the intricacies of Investor Side Letters.