An Alternative Investment Fund is a privately pooled investment vehicle that collects money from sophisticated investors to deploy according to a defined investment policy. Because AIFs are deliberately kept outside the retail-protective architecture of the SEBI (Mutual Funds) Regulations, 1996, SEBI compensates with a calibrated set of investment conditions that ride on top of the entry barriers, structural mandates, and conduct rules in the SEBI (Alternative Investment Funds) Regulations, 2012. These conditions answer four practical questions every fund manager must confront before the first cheque clears: who may invest, how much must be pooled, where the money may go, and how concentrated or leveraged the bets may be. This chapter maps those conditions provision by provision, from the threshold gates in Regulation 10 through the category-specific corridors in Regulations 15 to 18, and ties each to its regulatory logic.
The regulatory scheme: why AIFs are conditioned differently
The 2012 Regulations rest on a deliberate policy choice. A mutual fund solicits the retail public and is therefore hemmed in by daily net asset value disclosure, strict portfolio caps, and prohibitions explored in restrictions on AMC business activities. An AIF, by contrast, is a club of the wealthy and the informed; SEBI assumes its investors can fend for themselves and price their own risk. The trade-off is express in Regulation 2(1)(b), which defines an AIF as a privately pooled vehicle that raises funds from investors, whether Indian or foreign, for investing in accordance with a defined investment policy for the benefit of those investors.
The word privately is load-bearing. An AIF cannot make a public solicitation; it must raise capital through private placement. This single feature explains almost every downstream condition. Because the fund is private, SEBI does not police the deployment with the same granularity it applies to a mutual fund scheme, but it does erect threshold gates and concentration ceilings so that the privilege of light-touch regulation is confined to genuinely sophisticated capital. The conditions discussed below are best understood not as scattered rules but as the structural price of that privilege.
The three-fold categorisation drives the conditions. Category I AIFs invest in start-ups, SMEs, infrastructure and other socially or economically desirable sectors; Category II AIFs are the residual private-equity and debt funds that neither fall in Category I nor undertake leverage other than for day-to-day operations; Category III AIFs employ diverse or complex trading strategies and may use leverage, including through listed or unlisted derivatives. Each category attracts a different deployment corridor.
Threshold conditions under Regulation 10
Before deployment is even contemplated, an AIF must clear the gates in Regulation 10, which prescribes the conditions on which capital may be raised. The provision works as a filter to keep retail money out and to ensure the fund has enough scale to be viable.
Three numbers dominate. First, each scheme of an AIF must have a corpus of at least twenty crore rupees, the corpus being the total amount of funds committed by investors by way of a written contract. Second, the AIF must not accept from any single investor an investment of less than one crore rupees; the floor drops to twenty-five lakh rupees only for investors who are employees or directors of the AIF or of the manager, recognising that insiders should be free to co-invest in smaller amounts. Third, no scheme of an AIF may have more than one thousand investors, the cap that keeps the vehicle genuinely private; an angel fund, by contrast, may have up to two hundred angel investors in a scheme.
Regulation 10 also forbids the AIF from soliciting or collecting funds except by way of private placement, reinforcing the private character of the vehicle. These conditions interlock: a twenty-crore corpus drawn from investors each contributing at least one crore, capped at a thousand subscribers, by definition produces a pool of high-net-worth participants who do not need the retail safeguards built into the mutual fund framework.
Continuing interest: the manager's skin in the game
Regulation 10(d) imposes a co-investment discipline that aligns the manager's incentives with those of investors. The manager or sponsor must maintain a continuing interest in the AIF of not less than two and a half per cent of the corpus or five crore rupees, whichever is lower, and for a Category III AIF the threshold rises to five per cent of the corpus or ten crore rupees, whichever is lower. This interest must be in the form of investment in the AIF and cannot be through a waiver of management fees.
The provision performs the same function that sponsor net-worth and seed-contribution rules perform in the mutual fund context, where the architecture of the asset management company and the sponsor's eligibility and role are designed to guarantee accountable promoters. In an AIF the alignment is achieved by forcing the manager to ride alongside investors, bearing the same losses on the same securities. Because the manager's own capital is exposed, the deployment conditions that follow are partly self-enforcing: a manager who breaches a concentration limit risks his own money first.
General investment conditions under Regulation 15
Regulation 15 is the heart of the deployment regime. It opens with the principle that AIFs may invest in securities of companies incorporated outside India subject to conditions and guidelines stipulated by SEBI and the Reserve Bank of India, and then layers on the conditions that apply across categories.
The cornerstone is the concentration ceiling. A Category I or Category II AIF must not invest more than twenty-five per cent of its investable funds in a single investee company, whether directly or through investment in the units of other AIFs. A Category III AIF must not invest more than ten per cent of its investable funds in one investee company, again directly or through other AIF units. The phrase investable funds is itself defined as the corpus net of estimated expenditure for administration and management of the fund, so the limit bites on the deployable pool rather than the headline commitment.
Regulation 15 also governs the parking of idle cash. Until funds are deployed in line with the investment objective, the un-invested portion of the investable funds may be placed only in liquid mutual funds, bank deposits, or other liquid assets of higher quality such as treasury bills, Tri-party Repo, commercial paper, and certificates of deposit. The aim is to ensure that capital awaiting deployment is not exposed to market or credit risk inconsistent with the fund's profile. The Regulation further restricts an AIF that is itself authorised to invest in units of other AIFs from offering its own units for subscription to other AIFs, closing off circular fund-of-fund structures that would obscure the ultimate exposure.
Concentration norms and the diversification logic
The twenty-five and ten per cent ceilings deserve closer scrutiny because they are the conditions most frequently tested in practice and in examinations. The lower ten per cent cap for Category III reflects the higher-risk, higher-turnover trading strategies those funds pursue; concentration in a single name is more dangerous when the fund is leveraged or running complex derivative positions. The higher twenty-five per cent cap for Categories I and II accommodates the reality that venture, infrastructure and private-equity funds often take meaningful stakes in a small number of investee companies and add value through active stewardship.
Crucially, the limit is computed on investable funds and not on corpus, which means a fund with heavy estimated management and administration costs has a smaller base against which the percentage is measured. SEBI has clarified through informal guidance and circulars that the manager must apply the limit on a look-through basis where the AIF invests through another AIF, preventing the dilution of the cap by stacking vehicles. The diversification logic is identical to that animating the portfolio-concentration limits in the mutual fund world, but the thresholds are looser precisely because AIF investors are presumed able to bear concentration risk that retail mutual fund unitholders cannot.
Leverage conditions across categories
Leverage is the sharpest dividing line between the categories. A Category I AIF and a Category II AIF must not borrow funds directly or indirectly or engage in leverage except for meeting temporary funding requirements, and even then only for not more than thirty days, on not more than four occasions in a year, and not more than ten per cent of the investable funds. The cumulative cap stops these funds from running a perpetual borrowing book while still allowing them to bridge short-term liquidity gaps between a capital call and an investment.
A Category III AIF, by design, may engage in leverage or invest in listed or unlisted derivatives, but only subject to the consent of investors in the fund and subject to a maximum limit specified by SEBI. SEBI has fixed that maximum at two times the net asset value of the fund. Category III AIFs must also disclose information regarding the overall level of leverage employed, the level of leverage arising from borrowing of cash, the level arising from positions held in derivatives, and the main sources of leverage in the fund. This disclosure obligation is the regulatory quid pro quo for the freedom to leverage: investors who consent must be told, on a continuing basis, exactly how geared their fund has become.
Tenure conditions for close-ended schemes
Regulation 13 conditions the life of the fund. Category I and Category II AIFs are required to be close-ended, with a tenure determined at the time of application and a minimum tenure of three years. Category III AIFs may be open-ended or close-ended. The minimum-tenure rule for the first two categories reflects the illiquid, long-gestation nature of venture, infrastructure and private-equity investments, which cannot sensibly accommodate frequent redemptions.
The tenure of a close-ended AIF may be extended up to two years subject to the approval of two-thirds of the unitholders by value of their investment. A large value fund for accredited investors enjoys greater latitude and may extend its tenure up to five years on the same two-thirds approval. In the absence of unitholder consent, or upon expiry of the extended tenure, the fund or scheme must be wound up. These conditions ensure that capital is not trapped indefinitely and that any extension carries a genuine investor mandate, mirroring the unitholder-protection ethos that runs through the duties of the trustee's constitution and duties in the mutual fund framework.
Category I specific conditions under Regulation 16
Regulation 16 sets out the conditions that apply specifically to Category I AIFs, which include venture capital funds, SME funds, social venture funds and infrastructure funds. The defining condition is sectoral: a Category I AIF must invest in investee companies, venture capital undertakings, special purpose vehicles, limited liability partnerships or other AIFs as specified for its sub-category, and the investments must align with the positive-externality mandate that earns these funds their concessional treatment.
Venture capital funds, a sub-category of Category I, must invest at least two-thirds of their investable funds in unlisted equity shares or equity-linked instruments of a venture capital undertaking or in companies listed or proposed to be listed on an SME exchange. No more than one-third of the investable funds may be invested by way of subscription to the initial public offer of a venture capital undertaking whose shares are proposed to be listed, debt or debt instruments of a portfolio company in which the fund has already made an equity investment, or other permitted avenues. These conditions preserve the developmental character of Category I capital and keep it tilted toward genuine risk capital rather than secondary-market trading.
Category II specific conditions under Regulation 17
Regulation 17 conditions Category II AIFs, the largest category by assets, encompassing private-equity funds, debt funds and funds that do not fall in Categories I or III and do not undertake leverage other than for day-to-day operations. The conditions here are framed largely by reference to what these funds may not do.
A Category II AIF must invest primarily in unlisted investee companies or in the units of other AIFs as specified in its placement memorandum. It may engage in hedging subject to guidelines specified by SEBI, but it may not borrow or leverage except to meet temporary funding requirements within the thirty-day, four-occasion, ten-per-cent limit discussed above. A Category II AIF that has been registered as a debt fund may invest in debt or debt securities of listed or unlisted investee companies, but such a debt fund cannot accept the funds of other AIFs and its debt investments are subject to the SEBI framework for such instruments. These conditions confine Category II to a buy-and-hold private-markets profile, distinct both from the developmental focus of Category I and the active trading mandate of Category III.
Category III specific conditions under Regulation 18
Regulation 18 conditions Category III AIFs, which employ diverse or complex trading strategies and may invest in listed and unlisted derivatives. These are the hedge-fund-style vehicles, and their conditions reflect the elevated risk they carry.
A Category III AIF may invest in securities of listed or unlisted investee companies, in derivatives, in units of other AIFs, or in complex or structured products. It may buy and sell freely, including taking short positions through derivatives, and may employ leverage up to the two-times-NAV ceiling with investor consent. The continuing-interest requirement is set higher for this category, at five per cent of the corpus or ten crore rupees, whichever is lower, precisely because the strategies are riskier. Category III AIFs are also subject to enhanced reporting on leverage and risk, reflecting the regulator's heightened vigilance over funds that can amplify both gains and losses. The single-investee concentration ceiling for this category remains ten per cent of investable funds, the tightest of the three, so that leverage and concentration risk do not compound.
Overseas investment conditions
Regulation 15 permits AIFs to invest in securities of companies incorporated outside India, but the freedom is bounded by SEBI circulars and RBI conditions. SEBI has prescribed that an AIF may invest overseas, and the per-AIF exposure to overseas investments must not exceed twenty-five per cent of the investable funds of that AIF or scheme, within the overall industry-wide ceiling that SEBI allocates from time to time.
Historically the overseas window was confined to equity and equity-linked instruments of offshore venture capital undertakings, but SEBI has progressively liberalised the framework, moving toward permitting overseas investment in companies that have a connection with India and subjecting allocations to a first-come-first-served drawdown against the aggregate limit. The conditions ensure that capital flowing out of the domestic pool remains traceable, that it does not exceed the macro-prudential ceiling set jointly with the RBI, and that an individual fund cannot tilt its entire portfolio offshore. For examination purposes the operative number to remember is the twenty-five per cent per-fund cap on overseas exposure of investable funds.
Angel fund conditions
Angel funds occupy a special compartment within Category I as a sub-category of venture capital funds, and the 2012 Regulations carve out bespoke conditions for them in the dedicated chapter introduced by amendment. The relaxed thresholds recognise that angel investing operates at a far smaller scale than institutional venture capital.
An angel fund must have a corpus of at least five crore rupees rather than twenty crore, and an angel investor must commit at least twenty-five lakh rupees, which may be drawn down over a period. An angel investor who is an individual must have net tangible assets of at least two crore rupees excluding the value of the principal residence, and must have early-stage investment, serial entrepreneurship or at least ten years of senior management experience. A scheme of an angel fund may have up to two hundred angel investors. Investments by an angel fund in an investee company are subject to floor and ceiling limits and a lock-in, and the continuing-interest requirement for the manager or sponsor is calibrated down to two and a half per cent of the corpus or fifty lakh rupees, whichever is lower. These conditions deliberately lower the entry barrier so that genuine angel capital can reach start-ups without being crushed by institutional-scale compliance.
Pro-rata rights and investor fairness conditions
A significant addition to the conditions regime came through the 2024 amendments addressing pro-rata and pari-passu rights, which inserted a fairness principle into the deployment framework. Investors in a scheme of an AIF must now have rights pro-rata to their commitment to the scheme, both in each investment of the scheme and in the distribution of proceeds of that investment, except where SEBI specifies otherwise.
This principle directly targets the priority distribution model, under which some investors received returns ahead of others. AIFs that had adopted such a model and did not qualify for the limited grandfathering were directed to neither accept fresh commitments nor make investments in new investee companies until they conformed. Distribution of proceeds from investments made on or before the cut-off date was permitted to continue as per the existing distribution waterfall disclosed in fund documents. Angel funds are exempt from the pro-rata requirement given their bespoke structure, and large value funds for accredited investors may avail an exemption from the pari-passu requirement where their placement memorandum is filed after the relevant circular. The reform reflects SEBI's view that even sophisticated investors are entitled to economic equality within a scheme unless they knowingly contract out of it.
Enforcement and consequences of breach
The investment conditions are not aspirational; breach attracts the full enforcement machinery of the SEBI Act, 1992. Under Section 11 and Section 11B, SEBI may issue directions to an AIF or its manager, and under Section 15 the adjudicating officer may impose monetary penalties for contravention of the Regulations. SEBI has, in a series of orders, taken action against AIFs that exceeded concentration limits, breached the leverage ceiling, or used the AIF structure to facilitate evergreening of loans or circumvention of other regulatory norms.
The Securities Appellate Tribunal and the courts have repeatedly affirmed SEBI's wide remedial powers in this space. In SEBI v. Sahara India Real Estate Corporation Ltd., the Supreme Court underscored that SEBI's mandate to protect investors in collective investment and pooled vehicles must be read expansively, a principle that informs its supervision of AIFs even though Sahara itself concerned optionally convertible debentures. Equally, the Court's reasoning in SEBI v. Pan Asia Advisors Ltd. on the breadth of SEBI's jurisdiction over capital-market intermediaries supports its oversight of AIF managers as registered intermediaries. A manager who breaches the investment conditions therefore faces not merely a contractual grievance from investors but the prospect of registration cancellation, disgorgement, and penalty, making rigorous compliance with Regulations 10 to 18 a precondition of staying in business.
Frequently asked questions
What is the minimum investment an investor must make in an AIF?
Under Regulation 10, an AIF cannot accept an investment of less than one crore rupees from any single investor. The floor is reduced to twenty-five lakh rupees for investors who are employees or directors of the AIF or of the manager, and to twenty-five lakh rupees for angel investors in an angel fund.
How much of its investable funds can a Category III AIF invest in one investee company?
A Category III AIF cannot invest more than ten per cent of its investable funds in a single investee company, whether directly or through the units of other AIFs. This is tighter than the twenty-five per cent ceiling that applies to Category I and Category II AIFs, reflecting the higher-risk trading strategies and leverage that Category III funds employ.
Can a Category I or Category II AIF borrow money?
Only on a very limited basis. Such funds cannot leverage except to meet temporary funding requirements, and even then for not more than thirty days, on not more than four occasions in a year, and not more than ten per cent of the investable funds. Perpetual or structural borrowing is prohibited; only Category III AIFs may employ genuine leverage, up to two times the net asset value with investor consent.
What is the maximum number of investors permitted in an AIF scheme?
No scheme of an AIF may have more than one thousand investors, which is the condition that keeps the vehicle genuinely private and outside the retail-protective architecture of the mutual fund framework. An angel fund scheme, by contrast, may have up to two hundred angel investors.
What is the continuing interest requirement for an AIF manager?
The manager or sponsor must maintain a continuing interest of not less than two and a half per cent of the corpus or five crore rupees, whichever is lower. For a Category III AIF the threshold rises to five per cent of the corpus or ten crore rupees, whichever is lower. The interest must take the form of actual investment in the fund and cannot be satisfied by waiving management fees.
How long must a close-ended AIF run, and can its tenure be extended?
Category I and Category II AIFs must be close-ended with a minimum tenure of three years. The tenure may be extended by up to two years with the approval of two-thirds of the unitholders by value, while a large value fund for accredited investors may extend by up to five years on the same approval. Absent that consent, or on expiry of the extended tenure, the fund must be wound up.