Category 1 AIF & Angel Investor Networks in India

What is an Alternative Investment Fund (AIF)?

An Alternative Investment Fund (AIF) is a privately pooled investment vehicle that collects capital from investors and deploys it according to a defined investment strategy. Unlike mutual funds (which are heavily regulated and open to the general public), AIFs cater to accredited/sophisticated investors and pursue specialized investment strategies.

How AIFs Differ from Traditional Investment Vehicles

Three Categories of AIFs (SEBI Classification)

SEBI classifies AIFs into three distinct categories based on investment strategy and risk profile:

Category 1 AIF (Social/Economic Benefit Focus)

• Invest in startups, infrastructure, SMEs, social enterprises
• Tax benefits on pass-through basis
• Most relevant for startup founders
• Examples: Venture capital funds, angel funds, infrastructure funds

Category 2 AIF (Lower Risk)

• Invest in listed securities, debt, or diversified portfolio
• Some tax benefits (pass-through like Category 1)
• Lower risk but lower returns than Category 1
• Examples: Credit funds, debt funds, balanced funds

Category 3 AIF (Hedge Funds / Higher Risk)

• Higher risk, complex strategies (leverage, short-selling, derivatives)
• No tax benefits (taxed at fund level)
• Highest return potential but also highest risk
• Examples: Hedge funds, commodity funds, derivatives funds

Category 1 AIFs: The Startup Focus

Category 1 AIFs are the primary funding mechanism for startups in India. They invest capital in early-stage and growth-stage companies with the goal of achieving significant returns through exits (acquisitions, IPOs, secondary sales).

What Makes Category 1 AIFs Unique

• Policy Support: Indian government encourages Category 1 AIFs through tax incentives
• Startup Focus: Primary investment mandate is startups, SMEs, social ventures
• Long-term Horizon: 5-10 year investment horizon typical
• Active Management: Fund managers actively mentor and support portfolio companies
• Pass-through Taxation: Capital gains taxed at investor level, not fund level (creating tax efficiency)

Minimum Corpus & Investment Requirements

SEBI Regulations for Category 1 AIFs

Category 1 AIFs are governed by the SEBI (Alternative Investment Funds) Regulations, 2012, amended multiple times through 2025. Here are the key regulatory requirements:

Registration & Compliance Requirements

1. Fund Manager Registration

• Requirement: Fund must have a SEBI-registered fund manager
• Who Can Be FM: Company incorporated in India with track record of investing/managing funds
• Timeline: Registration process takes 4-8 weeks post-application
• Cost: ₹2.5 lakh to ₹5 lakh (registration fee to SEBI)

2. Private Placement Memorandum (PPM)

• Document: Detailed disclosure of fund strategy, risks, terms, fees
• Filing: Must be submitted to SEBI along with subscription documents
• Key Contents: Investment strategy, target returns, exit plan, risk factors, fee structure
• Format: Standard template; cost for legal drafting: ₹3-5 lakh typically

3. Investor Accreditation

• Requirement: All investors must qualify as “accredited investors”
• Ongoing: Fund manager must verify accreditation status before accepting investment
• Documentation: Accreditation certificate or self-declaration (if deemed accredited)

4. First Close & Onboarding

• Minimum Investors: At least 5 accredited investors (for angel funds)
• Timeline: First close must be declared within 12 months of PPM approval
• Lock-in: 1 year for regular investments; 6 months if exit is third-party sale

Annual Compliance & Reporting

Fund Manager Obligations (2025 Update)

Angel Funds: A Distinct Category 1 AIF (2025 Change)

Angel Funds are now a distinct sub-category of Category 1 AIF (as of September 2025), no longer grouped under Venture Capital Funds. This reflects the maturity and growth of India’s angel ecosystem.

What is an Angel Fund?

An Angel Fund is a pooled investment vehicle that collects capital from accredited “angel investors” and deploys it into early-stage startups (typically pre-Series A to Series A stage). Unlike individual angels, angel funds provide:

• Pooled capital (stronger checks to startups)
• Professional fund management
• Structured due diligence process
• Portfolio approach (diversification across 10-20+ companies)
• Mentorship and network support for portfolio companies

Angel Fund vs. Venture Capital Fund (Comparison)

Angel Fund Investment Lifecycle (2025 Rules)

1. Investment Decision: Fund identifies startup, conducts due diligence, makes investment decision
2. Investment Execution: Fund invests ₹10L-₹25Cr in startup (SEBI limit)
3. Lock-in Period: 1 year minimum (6 months if third-party sale)
4. Portfolio Engagement: Fund manager provides mentorship, introductions, support
5. Exit Options:
   • Acquisition by larger company
   • Follow-on funding (Series A+)
   • Secondary sale to other investors
   • Dividend returns (if profitable)
   • Write-off (if company fails)

Who Can Invest: Accredited Investor Requirements

SEBI defines “accredited investors” as individuals and entities with sufficient wealth and financial sophistication to participate in higher-risk investments like AIFs. Only accredited investors can invest in Category 1 AIFs.

Accredited Investor Criteria (SEBI 2025 Rules)

Deemed Accredited Investor Status (Special Cases)

SEBI allows certain categories to be “deemed” accredited without meeting the above criteria:

• Senior Management: CXOs, CFO, CTO of listed companies
• Professionals: Chartered Accountants, lawyers with 10+ years experience
• Fund Managers: SEBI-registered portfolio managers, fund managers
• Institutional Investors: Banks, insurance companies, pension funds, endowments
• Employees/Directors: Can invest below ₹25L minimum (fund/SEBI discretion)

Accreditation Verification Process

Documentation Required:

• Self-certification form (signed, notarized)
• Last 2 years income tax returns (ITR)
• Latest balance sheet or net worth certificate from CA
• KYC documents (Aadhaar, PAN, address proof)
• Bank statements (last 3 months)

Fund Manager Responsibility: Fund manager must verify accreditation before investment acceptance. Failure to verify correctly can result in SEBI penalties.

Angel Investor Networks in India

Beyond formal angel funds, India has a growing ecosystem of angel investor networks and platforms. These connect individual angels with startups for early-stage funding.

Top Angel Networks in India (2025)

How Angel Networks Work

For Startups:

• Apply to pitch at network demo day (free or ₹5K-₹25K fee)
• Pitch to group of 30-100+ angels (2-3 min elevator pitch)
• Follow-up meetings with interested angels (post-event)
• Negotiate term sheets 1-on-1 with individual angels
• Average funding received: ₹25L-₹2Cr from network connections

For Angels:

• Pay annual membership fee (₹15K-₹1L depending on network)
• Attend monthly/quarterly pitch events
• Access to deal flow (exclusive companies curated by network)
• Networking with other angels (syndication opportunities)
• Mentorship and portfolio management support

Individual Angel vs. Angel Fund (Comparison)

How Angel Fund Investments Work (Mechanics)

Investment Process Step-by-Step

1. Deal Sourcing (Week 1-2): Fund identifies startup through network, referrals, or platforms
2. Initial Screening (Week 2-3): Fund manager reviews pitch deck, founder background, market opportunity
3. Due Diligence (Week 3-6): Financial review, customer calls, technology audit, IP check
4. Investment Committee Meeting (Week 6-7): Fund team votes on investment decision
5. Term Sheet (Week 7): Fund sends term sheet with valuation, equity, terms
6. Legal Documentation (Week 7-8): Startup’s lawyer and fund’s lawyer negotiate final terms
7. Funding Close (Week 8-9): Wire transfer, equity allotment, cap table update

Term Sheet Expectations (Angel Fund Typical Terms)

Investment Agreement Components

A typical angel fund investment agreement includes:

• Investment Amount: How much being invested (in rupees)
• Equity Stake: Exact % or number of shares
• Rights & Preferences: Liquidation preference, anti-dilution, redemption rights
• Board/Observer Rights: Governance participation level
• Financial Covenants: Reporting requirements, approval thresholds for major decisions
• Lock-up Period: Minimum 1 year before founder can sell shares
• Founder Representations: Warranty that IP is clear, no pending litigation, etc.
• Exit Strategy: Path to liquidity (acquisition, IPO, secondary sales)

Tax Treatment & Benefits (2025 Updates)

Taxation is a critical consideration for both fund managers and investors. The 2025 Union Budget brought significant changes to AIF taxation.

Category 1 AIF Pass-Through Taxation Model

Key Principle: Category 1 AIFs benefit from “pass-through” taxation, meaning the fund itself is not taxed on most income. Instead, taxes are levied at the investor level.

2025 Union Budget Changes (Effective April 1, 2025)

Specific Tax Benefits for Category 1 AIFs

1. Infrastructure Investment Exemption

Category 1 AIFs investing in infrastructure projects (roads, ports, renewable energy) can claim exemptions under Section 10 of the Income Tax Act. This further reduces tax burden on certain investments.

2. Social Venture Exemption

Category 1 AIFs investing in healthcare, education, and other social ventures may receive exemptions. This encourages impact investing.

3. Dividend Distribution Tax (Eliminated)

As of 2020, dividend distribution tax was eliminated. Dividends now taxed at investor level (pass-through), creating more favorable treatment.

Investor-Level Tax Implications

For Resident Indian Investors:

• Capital gains taxed at 10% (long-term) or 15% (short-term)
• Plus applicable surcharge (0-37%) and 4% health & education cess
• Nature of gain retained (can claim indexation benefit if long-term)

For NRI / Foreign Investors:

• Capital gains subject to India tax treaty rates (if applicable)
• TCS (Tax Collected at Source) at 10% may apply
• Relief available under Double Taxation Avoidance Agreement (DTAA) with valid TRC

Fund Manager Carried Interest Taxation

Fund managers typically earn “carry” (20-25% of profits above hurdle rate). Carry is:

• Taxed as income in hands of fund manager (at applicable slab rate)
• Not subject to capital gains treatment (treated as business income)
• Must be declared in ITR as professional income

Recent 2025 Changes to AIF Regulations

SEBI announced major changes to Angel Fund regulations in September 2025, reflecting the growth of India’s angel ecosystem. Here’s what changed:

Key Regulatory Changes (Effective September 9, 2025)

1. Angel Funds as Distinct Category 1 AIF

Change: Angel Funds are now a separate sub-category under Category 1 AIF, distinct from Venture Capital Funds. Previously, they were grouped under “VC Funds.”

Impact: Clearer regulatory framework for angel funds; easier SEBI classification and compliance.

2. Investment Threshold Adjustments

Minimum investment per company: Lowered from ₹25 lakh to ₹10 lakh

Maximum investment per company: Increased from ₹10 crore to ₹25 crore

Impact: Allows more diverse startup sizes to receive angel funding; enables larger checks for proven companies approaching Series A.

3. Accredited Investor Focus

Change: Angel Funds can now raise capital exclusively from accredited investors (as defined). Accreditation verification is mandatory.

New Accreditation Criteria: Liquid worth of ₹5 crore + annual income of ₹50 lakh (individuals)

Impact: Higher investor quality, more investor protection, alignment with global standards.

4. Fund Manager Continuing Interest Requirement

Change: Fund manager or sponsor must maintain at least 0.5% of invested amount or ₹50,000 (whichever higher) in each investment.

Impact: Aligns fund manager incentives with investors; ensures manager has skin-in-the-game. Cannot be fulfilled by waiving fees.

5. Follow-on Investment & Co-Investment Flexibility

Change: Angel Funds can now invest up to 25% of investable funds in:

• Unlisted companies (beyond just startups)
• Units of other angel funds or Category 1 AIFs
• Follow-on investments in companies that no longer remain startups

Impact: Enables fund managers to support portfolio companies through later stages; creates ecosystem synergies.

6. Lock-in Period Clarification

Change: Lock-in period is 1 year minimum, but reduced to 6 months if exit is through third-party sale (excluding buyback/promoter purchase).

Impact: More liquidity options for investors while protecting startup growth period.

What These Changes Mean for Founders