SEBI’s Consultation on AIF Co-Investments: Implications for LPs

Co-investments have moved from being occasional niche arrangements to becoming strategic allocation mechanisms in the private funds industry. Globally, private equity and venture capital sponsors routinely offer select investors a chance to deploy additional capital alongside the main fund in particular deals. For fund managers, co-investments are a way to marshal more firepower for attractive opportunities and manage portfolio exposures without over-concentrating the primary fund. For limited partners (LPs), they are an avenue to selectively increase exposure to high-conviction investments – often on preferential fee terms – beyond their pro rata share in the fund.

In India, however, tapping co-investments has historically been fraught with regulatory and structural hurdles. SEBI only formalized a framework for “Co-investments”¹ in 2021 through linked amendments to the Alternative Investment Fund Regulations, 2012 (AIF Regulations) and the Portfolio Managers Regulations, 2020 (PM Regulations). Prior to this, while co-investments were not outright prohibited but fund sponsors discovered practical roadblocks: managing a coinvestment often meant needing an additional license, and pooling multiple co-investors into a single vehicle risked classification as an NBFC or an AIF registration requirement (triggering diversification norms). The 2021 amendments introduced a “Co-Investment Portfolio Manager”² (Portfolio Manager) mechanism as a workaround, removing some uncertainty and creating a pathway for AIF sponsors to facilitate co-investments within the regulatory fold.

SEBI’s recent consultation paper seeks to address some of those challenges by reimagining the co-investment framework through a dedicated “Co-Investment Vehicle” (CIV) scheme. Like it did in 2021, the regulator has negated the possibility of permitting co-investments within the AIF structure through separate classes of units. The decision rested on two key principles: first, that AIFs are fundamentally pooled vehicles where investor rights and returns must remain proportionate to their capital commitments; and second, that the pooling mechanism gives the AIF its distinct legal identity – an essential feature that should not be diluted.

In this piece, we’ll analyze what problems the proposed CIV framework aims to solve and whether the proposed reforms will substantively address the friction points identified by stakeholders, especially institutional LPs.

Challenges with the existing framework

The current co-investment framework, built around the Portfolio Management mechanism, has proven to be a double-edged sword: legitimizing co-investments while simultaneously introducing significant challenges –

• Fragmented shareholding. Under the Portfolio Manager model, each co-investor must hold the asset in its own name. This results in a fractured cap table for the investee company, often with a long list of individual shareholders. Such dispersion raises compliance burdens and documentation complexity, often making investee companies reluctant to accommodate coinvestments in the first place.
• LP Investment mandate limitations. Since co-investments are akin to direct investments by LPs, they must be permissible under the LP’s own investment charter. Where such direct investments are restricted, co-investments become unviable. And even when permitted, LPs typically undergo a prolonged due diligence process, followed by investment committee approval, making a supposedly nimble co-investment a protracted exercise.
• Rigid exit mechanics. The AIF Regulations mandate that co-investors exit alongside the AIF, on identical terms and timing. This rigidity removes flexibility for LPs who may want to liquidate early due to strategic shifts or liquidity preferences. In effect, the LP is tethered to the fund’s exit timeline with no room for maneuvering.
• Regulatory duplication and compliance burden. Obtaining a separate Portfolio Manager license adds significant compliance overhead. Domestic fund managers face restrictions not applicable to global peers, putting them at a disadvantage. Even where the co-investor is already an LP in the fund, they must sign separate portfolio management services (PMS) agreement, leading to procedural delays and potential inconsistency with the fund’s private placement memorandum (PPM).

SEBI’s proposal: A Co-Investment Vehicle with fewer fetters

At its core, the consultation paper admits that the current PMS-based co-investment framework (the CIPM route) is too restrictive, and it seeks to replace it with a more flexible, fund-based approach. Specifically, SEBI proposes to allow AIFs to offer co-investment opportunities within the AIF structure itself via a new construct called the Co-Investment Vehicle. The key proposals include:

• Regulatory relief. Under this proposed framework, a fund manager can launch a separate CIV scheme for each co-investment in unlisted securities. While these CIVs will be registered as AIF schemes matching the main fund’s category, they will be exempt from certain standard requirements such as diversification norms, minimum sponsor commitment, and minimum tenure conditions.
• Operational clarity. Each CIV must maintain its own bank and demat accounts and obtain a separate PAN to ensure traceability. Participation would be restricted to accredited investors. To streamline administration, AIFs would file a Shelf Placement Memorandum (“Shelf PPM”) at the time of registration (or via amendment for existing funds), outlining the broad strategy and eligibility criteria for co-investment offers.
• Ancillary changes. The consultation paper doesn’t stop at structural reconfiguration; it also addresses some of the ancillary regulatory irritants. For one, it proposes to remove the prohibition on AIF managers providing advice on listed securities (irrespective of whether the AIFs managed by them have made investments in such listed securities). That said, SEBI is justifiably cautious about market integrity: the paper floats a caveat that in case of “thinly traded” securities where the AIF is invested, there might still be restrictions.

Will CIVs Make Co-Investing Frictionless?

The proposed CIV model directly addresses several structural and procedural inefficiencies in the current co-investment framework, implementing the following key changes:

• Cap table fragmentation resolved – Instead of each co-investor being reflected as a separate shareholder in the investee company, the CIV becomes the sole shareholder. This avoids the administrative burden of managing multiple shareholder entries and sidesteps the discomfort that many portfolio companies have expressed around co-investments. It also simplifies documentation, voting, and shareholder decision-making.
• No direct exposure for LPs – Under the existing model, co-investing LPs hold securities directly in their name, triggering separate regulatory and internal policy hurdles. With the CIV structure, LPs invest through a pooled AIF scheme, eliminating the need for standalone due diligence or internal investment committee approvals that typically accompany direct exposure.
• Duplicate regulatory compliance eliminated – There is no longer a need for a separate Portfolio Manager registration, and the AIF manager can operate the CIV under its existing license. Co-investors are not required to sign a separate PMS agreement or receive separate disclosure documents. Instead, onboarding is streamlined through the Shelf Placement Memorandum filed at the time of fund registration.

Continuing concerns

Despite the above concerns being addressed, few issues remain. Firstly, the question of a coterminus exit for co-investors. While the working group has suggested that the exit should continue to be co-terminus, SEBI has left it open for stakeholders to provide their feedback. Historically, the AIF Industry has advocated having control over the exit of co-investors to protect the interest of AIFs investors.

Another issue that remains is the time it would take to register a CIV. Under the current framework, co-investments can be syndicated in tranches using the PMS route, allowing the AIF to invest first and subsequently bring in co-investors. However, the proposed CIV model would require registration and structuring of the CIV before funds are deployed. This may delay deal timelines for funds and investees looking to close investments quickly.

Conclusion

The introduction of the CIV model is certainly a step in the right direction towards making coinvestments easier. For LPs, the CIV model is a clear improvement. Large, institutional LPs often had to carry out independent due diligence when taking direct exposure to a portfolio company and also had to take separate investment committee approvals for such co-investments. The CIV framework will likely make co-investments relatively frictionless.

From the portfolio company’s perspective, the CIV model should be welcome news. Instead of several new shareholders, they get one CIV entity on board, no matter how many LPs are behind it. This should significantly ease the cap table and document management requirements, while decisions and consents can also be obtained much more smoothly.

1 Co-investment means investment made by a Manager or Sponsor or investor of Category I and II Alternative Investment Fund(s) in investee companies where such Category I or Category II Alternative Investment Fund(s) make investments: Provided that Co-investments by investors of Alternative Investment Fund shall be through a Co-investment Portfolio Manager as specified under the Securities and Exchange Board of India (Portfolio Managers) Regulation, 2020.
2 “Co- Investment Portfolio Manager means a Portfolio Manager who is a Manager of a Category I or II Alternative Investment Fund(s); and:
a. (i) provides services only to the investors of such Category I or II Alternative Investment Fund(s); and
b. (ii) makes investments only in unlisted securities of investee companies where such Category I or II Alternative Investment Fund(s) make investments:
Provided that the Co-investment Portfolio Manager may provide services to investors from any other Category I or Category II Alternative Investment Fund(s) which are managed by them and are also sponsored by the same Sponsor(s).”