[Alka Nanda Mahapatra is a student at the National Law University, Jodhpur]
On May 9, 2025, the Securities & Exchange Board of India (“SEBI”) released a Consultation Paper on providing flexibility to AIFs to offer Co-Investment opportunities to investors within the AIF structure under SEBI (Alternative Investment Funds) Regulations, 2012. The Consultation Paper released by SEBI proposes a major overhaul of the existing co-investment framework under the alternative investment funds (“AIF”) regime—one that has long been riddled with structural inefficiencies, regulatory gaps, and operational complexities. This post presents a comprehensive analysis of the prevailing regulatory framework governing co-investments, the practical challenges associated with it, the key features of the new model as outlined in the Consultation Paper, and a critical examination of its potential impact and effectiveness.
Current Framework for Co-Investment
Co-investment refers to an arrangement where an investor in an AIF is offered the opportunity to invest directly in the same company in which the AIF has made an investment. Such co-investments are typically made in unlisted securities of the investee company.
In current practice, co-investment is commonly executed through the portfolio management services (“PMS”) route. PMS is a service wherein a registered portfolio manager invests an investor’s funds in securities—including stocks, bonds, or other financial instruments—on behalf of the investor and in their name, creating a portfolio tailored to the investor’s individual risk appetite and investment strategy. PMS providers are regulated under the SEBI (Portfolio Managers) Regulations, 2020 (“PM Regulations”).
Under this framework, AIF Managers often obtain a separate PMS registration and structure bespoke co-investment arrangements for specific investors, typically large limited partners (“LPs”). These co-investments are governed by the PM Regulations and thus operate outside the AIF regulatory framework.
As a result, these PMS-based arrangements do not conform to the co-terminus exit requirement mandated under regulation 15(1)(b) of the SEBI (Alternative Investment Funds) Regulations, 2012 (“AIF Regulations”), which stipulates that co-investors must exit the investment at the same time as the AIF, and must not receive more favourable terms. The increasing reliance on the PMS route for co-investment has, in effect, led to a regulatory bypass of these safeguards, allowing investors to negotiate early exits or preferential terms that would otherwise be impermissible under the AIF regulations.
Problems with the Current Model
As can be expected, the PMS-based co-investment model has proven to be fraught with structural and regulatory inefficiencies. The key issues are detailed below:
Conflict of Interest at the Time of Exit
Under the PMS regime, clients have the option to terminate their contracts at any time and withdraw funds or securities, including those invested via co-investment. This flexibility allows PMS clients to exit earlier than the tenure of the AIF’s investment.
This creates a significant conflict of interest for the fund manager, who operates in a dual role as both PMS provider and AIF manager. The manager is expected to align co-investors’ interests with those of the AIF, but early exits by co-investors can compromise the fund’s negotiation power, distort exit valuations, and ultimately harm the interests of the AIF’s investors.
Additional Registration Burden
The Working Group on Ease of Doing Business (“WG”), constituted by SEBI, identified that requiring an AIF manager to also register separately as a portfolio manager imposes an unnecessary compliance and cost burden. More importantly, the PM Regulations impose conditionalities—such as customised exit rights and early liquidity—that are inconsistent with the long-term and pooled investment nature of AIFs.
This dual registration requirement reduces the competitiveness of domestic fund managers, especially when compared to global private equity funds that can offer co-investment flexibly without similar constraints. Moreover, the additional documentation, agreements, and structuring involved in setting up PMS-based co-investments makes the process administratively cumbersome, especially in cases involving multiple investors. This often delays deal execution and, in some cases, can cause entire transactions to collapse.
Expansive Definition of Co-Investment
The current regulatory definition of “co-investment” under the AIF framework is overly broad. It potentially captures scenarios where:
- an AIF investor is independently approached by a portfolio company, or
- the fund manager is not involved, charges no fees, and plays no active role in the transaction.
This overreach generates regulatory ambiguity and may deter legitimate, informal investment opportunities that do not actually raise conflict of interest concerns. A clearer, narrower definition would ensure that only manager-led co-investments fall within the purview of AIF oversight.
Restriction on Advising on Listed Securities
Presently, AIF managers are prohibited from advising co-investors or parallel funds on listed securities if the AIF is also invested in those securities. While the intention is to avoid conflicts of interest, this restriction appears disproportionate—particularly in the case of liquid and frequently traded securities—where market prices are transparent and influence from any one manager is negligible. Permitting such advisory activity, with adequate disclosures and safeguards, would streamline co-investment execution and align India’s regulatory practices with global standards.
Limited Scope for Offering Co-Investment Services
Under the current PMS model, co-investment services may only be offered where the sponsor and PMS manager are the same entity as the AIF sponsor/manager. This means cross-fund co-investments are not allowed. Such a restriction is both artificial and limiting. In modern fund structures, managers often oversee multiple AIFs with different sponsors, and this rule prevents them from efficiently matching capital with opportunity, even when the investor and deal are well aligned.
Concerns Around Power of Attorney (“PoA”) Execution
A key operational challenge in the PMS-based co-investment model relates to the execution of a PoA. While a PoA is critical for enabling the fund manager to act swiftly on behalf of the investor—especially in executing deal documents and coordinating exits—PMS clients typically retain direct legal ownership of the portfolio.
This leads to:
- reluctance by investors to delegate authority via PoA,
- fragmented decision-making across multiple PMS clients with different rights, and
- delays in executing transaction documents, participating in shareholder agreements, or aligning exit timelines.
This operational inefficiency directly undermines the speed and flexibility that co-investment arrangements require.
The Proposed Model
Pooling of capital is a defining feature of AIFs, where investor rights over investments and distribution of returns are allocated pro-rata to each investor’s commitment to the scheme. To preserve this pooled character, co-investments are currently not permitted within the AIF structure and are instead facilitated through a PMS arrangement.
However, based on the recommendations of the Working Group, the Consultation Paper proposes the creation of a co-investment vehicle (“CIV”) — a special scheme tagged to an AIF — specifically designed to facilitate co-investments by accredited investors. The CIV would allow such investors to co-invest in the same investee company in which the AIF is making an investment.
According to the consultation paper:
“CIV shall be a scheme of the AIF (Category I or Category II) which shall facilitate co-investment of investors of any scheme of the AIFs, in unlisted securities of the investee companies of the AIFs.”
Regulatory Framework Proposed for CIVs:
- Category Registration: CIVs shall be registered under the same category (Category I or II) as the main AIF to which they are linked.
- Shelf Private Placement Memorandum (“ShelfPPM”): At the time of AIF registration, a shelf Placement Memorandum (“PPM”) must be attached to the main AIF’s PPM. This shelf PPM shall include:
- the parameters of the co-investment rights offered,
- the co-investment policy of the Investment Manager (available to prospective investors prior to onboarding), and
- a clear statement that only Accredited Investors are eligible for co-investment opportunities.
- One CIV per co-investment: A new CIV scheme must be launched for each co-investment opportunity, under prior intimation to SEBI and in accordance with the Shelf PPM. Each CIV scheme shall maintain its own bank account, demat account, and PAN, ensuring full separation from the main AIF’s core scheme.
- Regulatory Exemptions: CIV schemes shall be exempt from the following requirements applicable to standard AIF schemes:
- diversification norms under regulations 15, 16, and 17, since CIVs are intended for single-investee co-investments,
- manager/sponsor commitment contributions, as the sponsor would already have fulfilled this obligation under the main AIF scheme, and
- minimum three-year tenure, recognizing the bespoke and shorter-term nature of co-investments.
- Tenure Alignment: The tenure of each CIV scheme shall be co-terminus with the tenure of the main AIF.
- Governance: CIVs shall be subject to implementation standards developed by the Standard Setting Forum for AIFs, to ensure that all co-investments are made for bona fide purposes and in a transparent and standardised manner.
Analysis of the Proposed Model
The proposed model for making co-investments via CIVs is a welcome move. It addresses several issues presently faced in the PMS model of co-investment, including the dual regulatory burden on AIF managers, inconsistent exit timelines, restrictions on investing in unlisted securities via PMS, lack of managerial control, and reliance on fragmented investor actions. Bringing co-investment within the AIF framework through a regulated CIV structure promises better clarity, alignment, and operational efficiency. The details of this proposal and its implications are analysed as follows.
Master CIV
The Working Group has recommended launching a separate CIV scheme for each co-investment. While this structure may be beneficial where 100% of the investible funds of the CIV are to be deployed in a single investee entity, there is merit in considering the introduction of a “Master CIV” model. This would allow for multiple co-investments under one CIV, provided they involve the same investee company and have identical terms and conditions. The Master CIV approach would significantly reduce administrative overhead, avoid duplication of documentation, and contribute to maintaining a clean capitalisation table for the fund.
It is well understood that AIFs are fundamentally structured around the principle of pooling capital and distributing returns pro-rata to investors. However, co-investments represent an acknowledged exception to this model. In fact, the very concept of creating a separate CIV per co-investment diverges from the core idea of pooled resources, which otherwise characterises AIFs. Therefore, introducing a Master CIV would remain consistent with the conceptual logic of co-investments as an exception—offering a separate scheme dedicated to accredited investors seeking exposure to specific investee companies on defined terms.
Discontinuation of Co-Investment via PMS Route
The proposal to discontinue the PMS route for co-investments is both timely and appropriate. Under the current framework, there exists the possibility for a co-investor to simultaneously use both the AIF-linked and PMS-linked routes to make parallel investments in the same company. This opens up potential conflicts of interest and weakens the integrity of the AIF structure. For instance, if a co-investor elects to withdraw a PMS-based investment prematurely, it could adversely impact the valuation, exit timeline, or strategic position of the AIF’s investment in the same company.
To mitigate this risk, it is essential that all new co-investments be routed exclusively through the CIV model. However, a blanket migration of existing PMS-based co-investments into the CIV framework would be counterproductive. These legacy investments should be permitted to continue until their natural exit, without imposing retrospective compliance burdens such as the filing of a shelf placement memorandum and other disclosure obligations. This staggered transition would ensure regulatory continuity without disrupting current investment strategies.
Co-Terminus Exit
The proposal to mandate a co-terminus exit—requiring that co-investors exit the investee company at the same time as the AIF—is a crucial step toward ensuring alignment of interest and fairness. While such a requirement may reduce the flexibility currently available to co-investors under the PMS model (where exit-at-will is permitted), the benefits of co-terminus exit clearly outweigh the costs. It prevents preferential treatment of co-investors, facilitates cleaner legal and financial execution at the time of exit, and protects the AIF’s negotiation power in strategic transactions. In coordinated exit scenarios, especially within the private equity and venture capital space, such alignment enhances the value realization potential for all stakeholders involved.
Advisory on Listed Securities
The current framework restricts AIF managers from advising co-investors or parallel funds on listed securities where the AIF is also invested. While the intent behind this restriction—namely, the prevention of conflicts of interest—is understandable, its application appears disproportionately rigid in the context of liquid and frequently traded listed securities, where pricing is entirely determined by market forces and information asymmetry is minimal. In such cases, the risk of conflict is negligible.
Accordingly, AIF managers should be permitted to provide advisory services in respect of listed securities, subject to appropriate disclosures and safeguards. However, SEBI’s concerns regarding thinly traded or illiquid listed securities are well-founded. In these cases, advisory activities should either be restricted or permitted only with enhanced transparency obligations, internal compliance oversight, and potentially additional investor consents.
Power of Attorney
One of the key operational difficulties with the PMS-based co-investment model is the delegation of authority through PoA. Since PMS clients retain direct legal ownership and control over their investments, managers often face resistance when requesting PoA for executing investment documents. This leads to fragmented decision-making, delays in signing shareholder agreements, and complications in coordinating exits—particularly in deals involving multiple PMS clients with differing rights.
The proposed CIV structure resolves this problem by enabling the manager to operate through a single, standardised PoA within the CIV scheme. This standardisation improves execution timelines, facilitates smoother governance, and ensures that the investment manager retains the necessary control to align co-investment decisions with the AIF’s broader strategy. It also reduces legal uncertainty and administrative inefficiency that have long hampered co-investment activity under the PMS framework.
Conclusion
The suggested CIV framework is a long-overdue overhaul of India’s co-investment regime. By relocating co-investments under the AIF umbrella, it tackles critical issues in the PMS model, such as regulatory overlap, dispersed control, and exit misalignment. Although the framework is a positive step, meticulous implementation—like permitting Master CIVs, facilitating the shift from PMS-based models, and demystifying advisory roles—will be critical. If implemented well, CIVs can optimize co-investment procedures, facilitate investor alignment, and align Indian AIFs with international benchmarks.
– Alka Nanda Mahapatra
