Sahyadri Credit: continuing interest, performance fee and an anchor investor's side deal
Sahyadri Credit Opportunities is a Category II AIF proposing an INR 80 crore debt fund; the first close is INR 40 crore from four investors. The manager intends to commit INR 1.2 crore as its continuing interest, made up of INR 0.8 crore of first-year management fee it will forgo and INR 0.4 crore in cash. One anchor investor committing INR 25 crore has asked for a 35 bps reduction in management fee and for the manager's units to carry a 12% preferred return ranking ahead of other investors. The manager also proposes a 15% performance fee on total gains, with no hurdle or high-water mark, and INR 1.4 crore of organisation costs to be charged to the scheme, of which INR 30 lakh is for the sponsor's own legal and tax advice on setting up the fund. The trustee has asked compliance to certify the fee section of the placement memorandum before the first close.
1. Compute the continuing interest required and assess whether the proposed INR 1.2 crore satisfies it.
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For a Category II AIF the manager or sponsor must maintain a continuing interest equal to the lower of 2.5% of the corpus and INR 5 crore, throughout the life of the scheme.
On the INR 80 crore corpus: 2.5% = INR 2 crore; that is below INR 5 crore, so the requirement is INR 2 crore.
The proposal fails twice over:
- INR 1.2 crore is short of INR 2 crore.
- INR 0.8 crore of it is a forgone management fee, not cash. Continuing interest must be an actual unencumbered investment in the scheme; fee waivers and set-offs do not count.
Only INR 0.4 crore of cash qualifies, leaving a shortfall of INR 1.6 crore of fresh cash commitment. Compliance should record this as an open item, and the manager should not withdraw or encumber the contribution later. If the registered corpus changes, the test must be re-run on the applicable corpus basis; staged closes do not dilute a scheme-level requirement, and the manager should not use a smaller first close to justify a smaller commitment.
2. Is the proposed performance fee and expense allocation acceptable? What should the placement memorandum say?
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Both proposals need rework.
Performance fee: a flat 15% of total gains, with no hurdle and no high-water mark, pays the manager for beta and for merely recovering earlier losses. Performance-linked fees should be charged only on the excess of return over a disclosed hurdle or benchmark, computed on net gains after fees and expenses, with the high-water-mark principle (and, for open-ended schemes, defined crystallisation frequency). For a close-ended scheme, a hurdle rate plus a defined crystallisation event at exit is the cleaner structure.
Expenses: only scheme-related costs that are disclosed and within disclosed limits may be charged to the scheme. The INR 30 lakh of the sponsor's own legal and tax advice on setting up the fund is the sponsor's cost, not an investor expense. The remaining INR 1.1 crore should be itemised, capped and disclosed.
The placement memorandum should set out the fee basis, hurdle, crystallisation, high-water mark, expense list and caps in clear terms, so that any invoice can be tested against it. Undisclosed or misclassified charges are a recurring enforcement theme.
3. How should the manager respond to the anchor investor's two demands?
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The two demands are not equivalent.
A negotiated fee concession can be acceptable only if it is a disclosed, documented class-of-units arrangement: the placement memorandum must show the fee grid, all investors must be able to see that large tickets carry different economics, and the arrangement must be applied consistently rather than through a secret side letter. If the documents permit only a single fee, a one-off discount is a fairness and disclosure problem.
A 12% preferred return on the manager's units should be refused. Continuing interest exists to align the manager with investors; giving it priority over investors inverts that alignment and amounts to downside protection for the sponsor. The manager's contribution should be unencumbered, at the same economics as other investors, and not withdrawn during the scheme's life.
If the anchor wants differentiated economics, the compliant route is a transparent, uniformly available ticket-size grid, approved by the trustee and disclosed to all investors, with no preferential payout to the sponsor. Compliance should also check whether any side letter has already been signed and, if so, disclose and unwind it before the first close.