Follow-on Investment Breaching the 25% Limit and an Early Redemption Request
A Category I venture capital fund has a corpus of Rs 250 crore and a declared tenure of eight years. It has already deployed Rs 60 crore in one portfolio company, representing 24% of the corpus. The investment committee wants to lead a follow-on round of Rs 15 crore in the same company because a new investor is offering a 20% discount to the last round. If completed, the exposure would be Rs 75 crore, or 30% of the corpus. Separately, an investor who committed Rs 5 crore at launch has asked for early redemption after three years to fund a property purchase. The fund’s PPM permits borrowing only for temporary operational needs and does not promise any liquidity window. The distributor is asked by the investor to find a buyer or arrange a loan from the fund. The fund has 80 investors.
1. Evaluate the proposed follow-on investment against the applicable concentration limit and the fund’s options.
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The follow-on would take exposure to Rs 75 crore, or 30% of the Rs 250 crore corpus. For a Category I/II scheme, the normal single-investee concentration limit is 25% of investable funds, which here is Rs 62.5 crore. The existing Rs 60 crore position leaves only Rs 2.5 crore of headroom. The fund therefore cannot simply approve the full Rs 15 crore follow-on. The investment committee should consider reducing the scheme’s commitment to Rs 2.5 crore and syndicating the balance through a co-investment vehicle outside the scheme, provided that structure is permitted and properly disclosed. Alternatively, the fund could seek investor consent if the regulations and PPM permit an exception, but that requires a proper approval process and full disclosure of the concentration risk. The 20% discount is not a reason to ignore the limit. The distributor should not describe the follow-on as routine until the limit and consent position are resolved.
2. How should the distributor respond to the investor’s early redemption request?
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The distributor should explain that the scheme is close-ended and that the investor has no right to redeem from the fund after three years. The PPM does not promise a liquidity window, and the fund cannot lend money to an investor to fund a property purchase. Arranging a loan from the fund would be inconsistent with the scheme’s permitted borrowing and would create a conflict with other investors. The distributor can explain the transfer route: a secondary sale of the investor’s units may be possible if the PPM and the manager permit it, the buyer is eligible and KYC-compliant, the transfer is documented, and the valuation is determined under the fund’s valuation policy. The distributor must not guarantee a buyer, a price or a timeline. It should record the request, the investor’s acknowledgement that no redemption is available, and any transfer enquiry. If the investor needs liquidity urgently, the distributor should say clearly that the investment is illiquid and that the request cannot be met from the fund.
3. What should the fund and distributor communicate if investor consent is sought for the concentration exception?
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Any consent request should give investors the facts needed to judge the exception: the current Rs 60 crore exposure, the proposed additional Rs 15 crore, the resulting 30% concentration, the 25% limit, the rationale for the follow-on, the 20% discount and its limitations, and the risks of increasing exposure to one company. The fund should state the approval threshold and process required by the regulations and the PPM, and should not treat silence as consent. The distributor should distinguish its role from that of the fund and should not pressure investors or imply that approval is a formality. Material conflicts, including any fee or carried-interest effect, should be disclosed. The communication should also explain what happens if consent is not obtained, such as reducing the scheme’s commitment or using a co-investment vehicle. The fund should retain the consent records and the distributor should retain the investor communications.