CHAPTER 14: REGULATORY FRAMEWORK (PART 4 OF 7)

Fund-Raising Timelines, Subscription Norms, Dematerialisation of Units, and the Step-by-Step Fund-Raising Process

1. First Close and Final Close: Declarations and Timelines

The lifecycle of an Alternative Investment Fund (AIF) scheme is strictly anchored around two pivotal milestone closures: the First Close and the Final Close [14.5.1].

I. The First Close

The First Close marks the formal date on which the AIF manager has pooled the minimum required threshold of capital commitments and is legally authorized to begin operationalizing the fund (e.g., executing the initial drawdowns, charging management fees, and initiating deal deployments) [14.5.1].

• The 12-Month Rule: For standard Category I and II AIF schemes, the First Close must be achieved and declared within 12 months from the date SEBI communicates that the Private Placement Memorandum (PPM) has been taken on record [14.5.2].
• Failed First Close Penalty: If the First Close is not declared within this 12-month window, the scheme is deemed to have failed [14.5.1]. The AIF cannot proceed with fundraising under that PPM, and the manager must file a fresh scheme application with SEBI, paying the full requisite registration fees again [14.5.1].
• Large Value Funds (LVFs) Exemption: For Large Value Funds (LVFs) catering to Accredited Investors, the First Close must be declared within 12 months from the date of grant of registration of the AIF or the date of filing of the scheme's PPM with SEBI, whichever is later [14.5.1].
• Minimum First Close Corpus: On the date of declaring the First Close, the total corpus of the AIF scheme shall not be less than INR 20 crore [14.5.1].
• Sponsor Lock: The Sponsor or Manager's mandatory continuing interest (skin-in-the-game) in the scheme cannot be reduced, withdrawn, or transferred after the declaration of the First Close [14.5.1].
• Legacy AIF Transition Rule: Existing AIF schemes whose PPMs were taken on record by SEBI prior to November 17, 2022, but had not declared their First Close by that date, were required to submit an updated PPM through a registered Merchant Banker with a fresh Due Diligence Certificate, and circulate this updated PPM to all prospective investors before declaring their First Close [14.5.1].

II. The Final Close

The Final Close marks the absolute end of the fund-raising window for a close-ended scheme [14.5.1].

• Sourcing Limit: Once the Final Close is declared, the scheme is strictly prohibited from accepting any fresh commitments or onboarding new investors [14.5.1].
• Timing: The timeline to achieve the Final Close from the date of the First Close is defined explicitly in the PPM (commonly 1 year, though it can vary) [14.5.1].
• Discretion Caps: For schemes that declared their First Close after November 17, 2022, the fund manager has no unilateral discretion to extend the Final Close timeline beyond what is registered in the PPM [14.5.1].
• Legacy Exception: Schemes that declared their First Close prior to November 17, 2022, are permitted to calculate their scheme tenure from the date of the Final Close, provided they close fundraising within the timelines defined in their original PPMs [14.5.1].

2. Scheme Tenure and the Extension Framework

All close-ended Category I and II AIF schemes must declare their formal operating term upfront [14.3.2, 14.5.2].

• Minimum Scheme Term: The minimum permitted tenure for any close-ended Category I or II AIF scheme is 3 years [14.5.2].
• Tenure Computation Rule: The tenure of the scheme is computed from the date of the declaration of the First Close [14.5.2].
• Pre-First Close Flexibilities: The manager is permitted to modify the tenure of a scheme at any point before the First Close is declared [14.5.2]. During this pre-First Close phase, investors also have the right to withdraw or reduce their capital commitments [14.5.2].
• The Extension Gate:
  • The tenure of a close-ended scheme can be extended for a maximum of 2 years [14.5.2].
  • This extension requires the prior formal approval of at least two-thirds (2/3rds) of the unitholders by value of their investment in the scheme [14.5.2].
  • For Large Value Funds (LVFs), extensions can be granted for up to 5 years, subject to the same two-thirds majority by value [12.2.5].
• Mandatory Liquidation on Expiry: In the absence of the requisite two-thirds consent for an extension, or once the extended tenure expires, the AIF must immediately cease investment activities and fully liquidate its assets within 1 year (the "Liquidation Period") [14.5.2].

3. Investor Subscription Thresholds

To ensure that alternative assets are only accessed by sophisticated investors who can bear high capital risks, SEBI enforces strict minimum investment tickets [14.6]:

• Accredited Investor Exemption: These minimum thresholds do not apply to verified Accredited Investors [14.6].

4. Dematerialisation of AIF Units

To promote market safety, simplify unit transfers, and ensure a robust audit trail, SEBI has made the dematerialisation (demat) of AIF units mandatory [14.7].

I. Core Demat Requirements

• All registered AIFs must issue their units in dematerialised form [14.7].
• Units can only be issued or allocated once the investor’s drawdown money has been received and the applicable stamp duty has been paid [4.1.5].

II. The Aggregate Escrow Demat Account Mechanism

When an AIF is transitioning to demat form, some legacy or existing investors may fail to provide their personal demat account details in time. To prevent halting fund operations, SEBI and the Standard Setting Forum for AIFs (SFA) established the Aggregate Escrow Demat Account [14.7]:

1. Temporary Custody: Any units issued to investors who have not provided demat details must be credited to a separate, temporary demat account opened by the AIF, designated as the "Aggregate Escrow Demat Account" [14.7].
2. Strict Transfer Rule: Once the investor provides their valid demat account details, the manager must transfer the units out of the Aggregate Escrow Demat Account and credit them to the investor's individual demat account within 5 working days [14.7].
3. Prohibition of Secondary Trades: No other transfer of units from, within, or between Aggregate Escrow Demat Accounts is permitted [14.7].
4. Redemption & Distribution: Units held within the Aggregate Escrow Demat Account can be redeemed normally, with the proceeds distributed directly to the respective investor's registered bank account, maintaining a full audit trail [14.7].

III. Detailed Demat Timeline Matrix

The compliance deadlines for transitioning to mandatory demat were phased based on the scheme's corpus size as of October 31, 2023 [14.7]:

5. Raising Corpus Capital and Private Placement Norms

To preserve the non-public nature of AIFs, capital-raising is heavily guarded by private placement boundaries [14.8]:

• The Private Placement Mandate: An AIF can only solicit or collect funds by way of private placement using a registered PPM [14.8]. Public solicitation, advertisements, or open invitations to the public are strictly prohibited [14.1.2].
• The 1000-Investor Cap: No scheme of an AIF shall onboard more than 1000 investors [4.1.5].
• The Company Structure Conflict: If the AIF is structured as a Company, the investor cap is restricted by Section 42 of the Companies Act, 2013, which limits private placements to not more than 200 investors [14.8].
• FEMA Conformity: An AIF can raise capital from Indian, foreign, or non-resident Indian (NRI) investors, but all foreign inflows must strictly conform to the Foreign Exchange Management Act (FEMA), 1999 and Reserve Bank of India (RBI) rules [14.8].
• Social Units: Social Impact Funds are permitted to issue "social units" to investors who agree to receive only social returns/benefits and waive their rights to financial returns [14.8].

6. The Step-by-Step Fund-Raising Process (Table 14.1)

The journey of an AIF from its conceptualization to its final fund-raise closure is executed in eight chronological steps [14.8]:

Step-by-Step Process:

• Step 1: Fund Formation with all Fund Constituents The Sponsor or Investment Manager forms the legal entity (typically a trust) and appoints key constituents: the Trustee, Custodian, Fund Accountant, Registrar and Transfer Agent (RTA), and legal advisors [14.8].
• Step 2: Apply for SEBI Registration The manager drafts the Private Placement Memorandum (PPM) and submits a formal application via SEBI's online portal using Form A through a registered Merchant Banker [14.8].
• Step 3: Receive SEBI In-principle Approval SEBI grants in-principle approval. The fund uses this to set up bank accounts, custody accounts, register on the SEBI SCORES grievance platform, and obtain SEBI login credentials [14.8].
• Step 4: Appoint Distributors and Initiate taking Capital Commitments The fund aligns with registered distributors and approaches sophisticated investors to secure capital commitments (subscription agreements), but is strictly prohibited from calling or accepting actual investment cash [14.8].
• Step 5: Obtain SEBI Registration Certificate The fund pays the designated registration and application fees to SEBI and receives the final Certificate of Registration in Form B [14.8].
• Step 6: First Close The fund secures its target minimum capital commitments (corpus must be at least INR 20 crore), calls up the initial drawdown money from investors, launches active investing, and begins declaring Net Asset Value (NAV) [14.8].
• Step 7: Make Capital Calls during Drawdown Period As deal opportunities arise, the manager issues formal drawdown notices to call up the remaining uncalled commitments (dry powder) to finance acquisitions [14.8].
• Step 8: Final Close The fund completes its capital-raising window, achieves its total target corpus, and declares the Final Close, locking the fund size and halting all fresh investor entry [14.8].

7. Practical Scenarios & Worked Case Studies

Scenario A: The Failed First Close Timeline

• The Situation: Phoenix Tech Venture Fund (a Category I AIF) received communication from SEBI taking its PPM on record on January 1, 2025. Due to a sudden market downturn, the fund manager struggled to secure commitments. By January 15, 2026 (12.5 months later), they finally secured INR 22 crore in commitments and declared their First Close.
• The Regulatory Verdict: The First Close is legally invalid. Standard Category I and II AIFs must declare their First Close within 12 months of SEBI taking their PPM on record. Since Phoenix missed this deadline, they cannot operationalize the fund under this PPM. They must return any commitments, file a completely fresh scheme application with SEBI, and pay the registration fees again.

Scenario B: The Escrow Demat Delay

• The Situation: Titan PE Fund (corpus of INR 100 crore) launched on June 1, 2024. One of its early investors, Heritage Family Office, committed INR 5 crore but repeatedly delayed opening a depository account. On June 15, 2024, the fund manager issued units to Heritage and credited them to the fund’s Aggregate Escrow Demat Account. Heritage finally opened a demat account and sent the details to the manager on July 1. The manager, busy with a deal closure, processed the transfer on July 15.
• The Regulatory Verdict: This is a compliance violation by the manager. While the manager correctly used the Aggregate Escrow Demat Account to temporarily house the units, the regulations strictly mandate that units must be transferred to the investor's individual demat account within 5 working days of receiving their details. Taking 14 days (from July 1 to July 15) violates the SFA implementation standards and will be flagged in the annual PPM compliance audit.

8. Key Takeaways & Exam-Relevant Terms

• First Close: The formal launch date of an AIF scheme; must be declared within 12 months of SEBI taking the PPM on record.
• Failed First Close: Occurs if First Close is not achieved within 12 months, requiring a brand-new SEBI filing.
• Minimum Scheme Tenure: Fixed at 3 years for close-ended Category I and II AIFs, calculated from the First Close date.
• Aggregate Escrow Demat Account: A temporary demat account used by AIFs to hold units for onboarded investors who have not yet provided their depository details.
• 5-Day Transfer Rule: The mandatory timeline for an AIF manager to transfer units out of the Aggregate Escrow Demat Account to an investor's personal account once details are provided.
• Standard Minimum Subscription: INR 1 crore (except for employees/directors at INR 25 lakh, and Social Impact Funds at INR 2 lakh).
• Investor Cap: Strictly limited to 1000 investors per scheme (reduced to 200 if structured as a Company under the Companies Act).