Ashutosh Gupta
Policy Update
Introduction
In recent years, India has experienced a significant transformation in its entrepreneurial environment, establishing itself as the third-largest startup ecosystem in the world. To promote this dynamic expansion, the Government of India established the Alternate Investment Funds (AIFs) framework, with a significant initiative being the Fund of Funds for Startups (FFS), which was initiated in 2016 as part of the Startup India campaign. Administered by the Small Industries Development Bank of India (SIDBI), AIFs are overseen by the Securities and Exchange Board of India (SEBI) and intended to direct domestic and institutional investments into startups, especially in their early and growth phases.
This policy approach aims to close the financial gap, attract private capital, and encourage growth driven by innovation. AIFs are becoming increasingly important in fostering job creation, regional economic balance, and global competitiveness as India moves closer to being a $5 trillion economy.
Inception and Regulatory Framework
The Securities and Exchange Board of India (SEBI) implemented the AIFs (Alternative Investment Funds) Regulations in May 2012 to oversee pooled investment vehicles that had not been regulated before. The main goal was to improve systemic stability, boost market efficiency, promote new capital creation, and safeguard investor interests. These rules classified AIFs into three separate categories:
- Category I AIFs: These funds target sectors that benefit the economy, including Venture Capital, social enterprises, Small and Medium-sized Enterprises (SMEs), infrastructure, and startups.
- Category II AIFs: These funds function without designated incentives and allocate resources across various instruments, such as private equity and debt funds.
- Category III AIFs: These funds utilize intricate trading strategies, such as hedge funds, aimed at achieving short-term gains.
Among these, Category I AIFs, especially Venture Capital Funds (VCFs), hold significant importance for startups, offering initial funding to encourage innovation and entrepreneurial efforts.
Fig 1: Categories of AIFs
Source – paisabazaar.com
Need and Objectives
Prior to the introduction of AIF regulations, several unregulated funds functioned in India, raising worries about investor safety and market stability. The purpose of introducing AIFs was to:
- Oversee Unregistered Funds: Placing every investment fund within an organized regulatory system to reduce systemic risks.
- Encourage Investment in Key Sectors: Fostering investments in areas with substantial growth prospects and socio-economic advantages, including startups and SMEs.
- Improve Clarity and Oversight: Establishing disclosure guidelines and governance practices to safeguard investor interests.
Evolution and Key Amendments
Since their introduction, AIF regulations have undergone numerous updates to align with the changing investment environment:
- May 2021 Amendment: SEBI modified the definition of ‘startup’ to match the criteria laid out by the Department for Promotion of Industry and Internal Trade (DPIIT). This alignment offered clarity and consistency in recognizing qualifying startups for investments by Angel Funds.
- Investment Restrictions: The modification further stipulated that Category I and II AIFs were allowed to allocate a maximum of 25% of their investable assets to any single investee firm, whereas Category III AIFs had a limit of 10%. These restrictions were intended to guarantee diversification and minimize risk.
- Code of Conduct: A detailed code of conduct was established for AIFs, their managers, and essential personnel to improve accountability and transparency in their operations.
Recent Developments
In November 2024, SEBI suggested raising investment limits for angel funds (a fund of investment capital from a network of High Net-worth Individuals (HNIs) or companies) to broaden the investor community and improve financing for startups. The proposal recommended establishing the investment range from ₹1 million to ₹250 million, replacing the earlier range of ₹2.5 million to ₹100 million.
Functioning of AIFs within the Startup Ecosystem
In India, AIFs function according to the regulatory structure set by the Securities and Exchange Board of India (SEBI) via the AIFs(Alternative Investment Funds) Regulations, 2012. These funds are divided into three categories, with Category I AIFs especially significant for startups. This category comprises Venture Capital Funds, Angel Funds, and SME Funds, all focused on investing in early-stage companies with significant growth potential.
The usual operation of these AIFs includes:
- Fundraising: AIF managers acquire funds from High Net-worth Individuals (HNIs), institutional backers, and other qualified organizations.
- Investment: The combined funds are allocated to startups and small to medium-sized enterprises that correspond with the fund’s investment strategy and goals.
- Management and Assistance: In addition to financial backing, AIFs typically offer strategic advice, mentorship, and network access, supporting the operational and strategic growth of the invested companies.
- Exit: After a specified duration, usually between 5 to 10 years, AIFs aim to divest their investments via different methods like Initial Public Offerings (IPOs), mergers and acquisitions, or secondary sales, with the objective of producing returns for their investors.
Fig 2: Typical AIF Structure
Performance Overview (2021-2024)
The Securities and Exchange Board of India (SEBI) offers detailed information on activities related to AIF. Based on the most recent data:
Funds Raised: ₹12,43,083 crore
Total Amount Raised: ₹5,01,503 crore
Investments Totalled: ₹4,49,384 crore
These numbers highlight a significant dedication and allocation of resources in the AIF sector.
Fund of Funds for Startups (FFS) Program
Inaugurated as part of the Startup India initiative in 2016, the FFS program has greatly aided startup funding:
- Government Pledges: As of September 2022, the government allocated ₹7,385 crore to 88 AIFs.
- Investments in Startups: These AIFs have allocated ₹13,493 crore to 773 startups.
This shows a Compounded annual growth rate (CAGR) exceeding 21% in commitments since the launch of the program.
Investments in New Businesses
The Economic Survey 2023-24 indicates that 135 AIFs have allocated more than ₹18,000 crore to startups by the conclusion of FY24. This signals a strong and increasing involvement of AIFs in supporting early-stage businesses.
Detailed Analysis by AIF Categories
SEBI categorizes AIFs into three groups, each emphasizing different investment priorities:
According to data from SEBI:
Commitments Raised: ₹83,493 crore
Amount Collected: ₹45,797 crore
Investments Executed: ₹39,115 crore
Commitments Raised: ₹9,76,045 crores
Amount Collected: ₹3,44,474 crore
Funds Invested: ₹2,86,959 crore
Total Commitments: ₹1,83,545 crore
Capital Collected: ₹1,11,232 crore
Investments Executed: ₹1,23,310 crore
Fig 3: Category wise AIF commitments
Source: business standard
Impact Assessment
Mobilization of Funds and Assistance for Startups
As of December 31, 2022, the FFS program allocated ₹7,980 crore to 99 AIFs, having disbursed ₹3,400 crore to 72 of them. These AIFs allocated ₹14,077 crore to 791 startups, showcasing a significant multiplier impact in attracting private investment.
By December 2024, commitments rose to ₹11,687 crore, aiding 1,173 startups. This increase demonstrates the program’s success in boosting funding for startups.
Economic Development and Employment Generation
The startup environment has grown substantially, featuring more than 114,000 startups across all 36 States and Union Territories and generating over 1.2 million jobs. This increase corresponds with the policy’s aim of promoting economic growth and job creation.
Diversification of Investment Sources
AIFs offer varied funding options for startups, drawing interest from both local and global investors. The industry is expected to expand at a Compound annual growth rate (CAGR) of 26% in the coming five years, possibly exceeding mutual funds and various investment vehicles.
Fig 4: Investor trend in AIFs
Source: business standard
Emerging Challenges in the Use of AIFs for Startups
- AIFs’ Regulatory Arbitrage: Instances of abuse and evasion of financial regulations by a few AIFs.
- Urban Concentration of Startups: Funds mostly go into Tier 1 cities, overlooking Tier 2 and Tier 3 ecosystems.
- Squeezed Early-Stage Funding: AIFs’ risk aversion has resulted in underfunding of early-stage and deep-tech startups.
- Investor Awareness and Participation: Domestic retail and institutional investor awareness is limited.
- Delayed Fund Disbursement: Delays in disbursing committed funds to AIFs and start-ups due to bureaucratic reasons.
- Data Transparency and Tracking: Lack of real-time public dashboards to track AIF deployment and impact.
Way Ahead
- Encouraging inclusive financing by motivating AIFs to back startups in developing areas and industries.
- Enhancing regulatory supervision through automated compliance verification and clear data reporting systems.
- Boosting initial risk capital via co-investment programs and focused government-supported AIFs.
- Promoting financial understanding and awareness among investors to strengthen domestic capital markets.
- Optimising fund management by digitizing procedures through SIDBI and other coordinating agencies.
- Regularly assessing the impact by utilizing outcomes connected to Key Performance Indicators (KPIs) for startups that receive AIF assistance.
Conclusion
The Alternate Investment Funds (AIFs) structure, especially via the Fund of Funds for Startups (FFS), has become a driving force in fostering India’s startup environment. It has effectively gathered substantial local capital, aided more than 1,000 startups, and played a role in job creation as well as regional economic growth. Notwithstanding its successes, issues like regulatory shortcomings, concentration in Tier 1 centers, limited early-stage funding, and inadequate investor awareness continue to exist. Tackling these concerns necessitates joint actions from policymakers, regulators, fund managers, and investors to guarantee transparency, inclusiveness, and sustainability.
Enhancing the regulatory structure, encouraging fair allocation of funds, and developing capacity for startup preparedness will boost the lasting effects of AIFs. As India advances towards establishing itself as a global center for innovation, AIFs need to adapt to support the vision of “New India” by promoting entrepreneurship, innovation, and inclusive development. The ongoing success of the policy depends on flexible governance, data-informed assessments, and strong stakeholder involvement.
References
1. Ministry of Commerce and Industry. (2022, September 30). Fund of Funds for Startups (FFS) Scheme: Details and progress. Press Information Bureau.
https://pib.gov.in/PressReleasePage.aspx?PRID=1862374
2. Ministry of Commerce and Industry. (2023, May 18). Startup India: State-wise Startup growth and impact. Press Information Bureau.
https://static.pib.gov.in/WriteReadData/specificdocs/documents/2023/may/doc2023518199901.pdf
3. Ministry of Commerce and Industry. (2023, July 21). Economic Survey 2022-23: Startup India overview and AIF impact. Press Information Bureau.
https://pib.gov.in/PressReleasePage.aspx?PRID=2034921
4. Ministry of Commerce and Industry. (2022, December 31). Government’s commitment under FFS and performance of AIFs. Press Information Bureau.
https://pib.gov.in/Pressreleaseshare.aspx?PRID=1895964
5. Ministry of Commerce and Industry. (2024, February 3). Latest update on Fund of Funds and AIF disbursals. Press Information Bureau.
https://pib.gov.in/PressReleseDetailm.aspx?PRID=2098452
6. Ministry of Commerce and Industry. (2023, July 18). Startup India scheme contribution to jobs and economic growth. Press Information Bureau.
https://pib.gov.in/PressReleaseIframePage.aspx?PRID=1990377
7. Securities and Exchange Board of India. (2023). AIF Statistics – Quarterly data update.
https://www.sebi.gov.in/statistics/1392982252002.html
8. Securities and Exchange Board of India. (2024, April 15). Meeting notes: Steps to curb regulatory misuse by AIFs.
https://www.sebi.gov.in/sebi_data/meetingfiles/apr-2024/1713324885850_1.pdf
9. Enterslice. (2023, August 21). How AIFs are fueling tech startups in India. https://enterslice.com/learning/how-aifs-are-fueling-tech-startups-in-india/
10. Centre for Business and Financial Laws, National Law University Delhi. (2023, November). Assessing progress and hurdles of India’s Alternative Investment industry.
About the Contributor: Ashutosh Gupta is a Research Intern at IMPRI. He is pursuing his Master’s Programme in International Relations and Area Studies from MMAJ Academy of International Studies at Jamia Millia Islamia University (JMI).
Acknowledgement: The author extends his sincere gratitude to the IMPRI team and Ms. Aasthaba Jadeja for her invaluable guidance throughout the process.
Disclaimer: All views expressed in the article belong solely to the author and not necessarily to the organisation.
Read more at IMPRI:
Unlocking Public Assets – Evaluating India’s Asset Monetization Plan 2025-30
