AIF Sponsor Commitment and Continuing Interest: SEBI Rules

Every investor in a fund asks the same question early: how much of their own money is the manager putting in? SEBI answers part of it by law. Under the SEBI (Alternative Investment Funds) Regulations, 2012, the sponsor or the manager must hold a continuing interest in the fund, usually called skin in the game, and that interest must be real money invested in the fund.

This note explains who the sponsor and manager are, how much they must commit in each category, how the commitment is usually funded and where sponsors go wrong. For context: I am Strategic Advisor at Stonebridge Advisors LLP, Sponsor and Investment Manager of Anchor Rock Investment Fund - I, a SEBI-registered Category III Alternative Investment Fund. What follows is general guidance, not legal advice.

Sponsor, manager and trustee: who does what

The sponsor is the person or entity that sets up the AIF: the settlor of a trust, the promoter of a company or the designated partner of an LLP. The manager runs the investments and deals with SEBI day to day. In a trust-form fund, the trustee holds the assets for investors and oversees the manager.

One entity can be both sponsor and manager, which is common for first-time funds, provided it meets the conditions for each role. Either way, the manager must pass the fit and proper test and field a key investment team with the experience and certification SEBI prescribes.

The continuing interest rule, category by category

The interest must be held as an investment in the fund itself, not through a waiver of management fees, and must be disclosed to investors. It is measured against the corpus, meaning total investor commitments, so it grows with the fund until the rupee cap applies.

The regulations set a floor, not a target. The current rules, each of which can change, are:

• Category I and II: the lower of 2.5 per cent of the corpus or Rs 5 crore.
• Category III: the lower of 5 per cent of the corpus or Rs 10 crore.
• Angel funds: a separate angel-fund rule applies; check the current regulation before you plan.
• Co-investment vehicle (CIV) schemes for accredited investors: exempt from the continuing interest requirement.

Why the legal minimum is rarely the real number

The legal floor is modest next to what institutional investors often expect. Domestic institutions, development finance institutions and family offices commonly look for a meaningful sponsor commitment as evidence of alignment, and they read the rupee cap as a compliance floor, not a signal of conviction.

Because the interest is continuing, plan for the money to stay in for the full life of the scheme, extensions included. A commitment sized only to clear the regulatory floor at the first close can leave the sponsor short when later closes grow the corpus.

Funding the commitment in practice

Typically the sponsor commitment is drawn down alongside investors under the contribution agreement, so the sponsor needs cash when each call is made, not only at the first close. A sponsor that misses a call risks breaching a regulatory condition as well as a contract.

Where the sponsor is an LLP or a company, fund the commitment from its own capital or from partner or shareholder contributions, and document the source, because SEBI and investors both look at where the money came from. Borrowing to fund it needs careful thought, because investors read a leveraged commitment as weaker alignment.

Employees and directors of the fund or its manager can invest with a lower minimum of Rs 25 lakh, a useful way to widen the team's alignment beyond the sponsor entity.

Carry, fees and the team's economics

Carried interest is usually delivered through a separate class of units issued to the manager or its team, with a distribution waterfall set out in the PPM. SEBI's pro-rata and pari-passu rules require investors to share in returns in proportion to their commitments, with limited carve-outs, so the carry and any differential rights have to be drafted inside those rules.

The tax treatment of carry is not settled in India: whether it is a capital gain on units or income for services is debated, and the answer can depend on facts. Management fees charged by the manager attract GST at the rate in force. Model both before you finalise the waterfall.

Mistakes that cost time or money

Most problems with sponsor commitments are avoidable, but they sit between the legal, tax and FEMA workstreams and are easy to miss. The common ones are listed below.

Settle these points in one term sheet for the sponsor and manager before counsel starts drafting, so that the PPM, the trust deed and the investment management agreement agree with each other.

• Treating a fee waiver as the continuing interest; it does not count.
• Sizing the commitment on the first close only, then missing the top-up as later closes grow the corpus.
• A foreign-owned or foreign-controlled sponsor or manager, which can make every downstream investment count as foreign investment under FEMA.
• Not disclosing the sponsor and manager investment to investors.
• Carry or priority returns drafted in conflict with SEBI's pro-rata rules.

Frequently asked questions

How much must an AIF sponsor invest?

The lower of 2.5 per cent of the corpus or Rs 5 crore for Category I and II funds, and the lower of 5 per cent or Rs 10 crore for Category III. Investors often expect more than the legal floor.

Can the manager hold the continuing interest instead of the sponsor?

Yes. The rule is framed as an interest held by the manager or the sponsor, so either can hold it. What matters is that it is invested in the fund and disclosed.

Can a sponsor waive management fees instead of investing?

Not as a substitute. The continuing interest must be an actual investment in the fund, not a waiver of management fees. A fee waiver can still be offered commercially, but it does not satisfy the rule.

Does a foreign sponsor change how the AIF invests?

It can. If the sponsor or manager is not owned and controlled by resident Indian citizens, or is owned or controlled by non-residents, the AIF's downstream investments count as foreign investment under FEMA, bringing sectoral caps, pricing rules and reporting into every deal.

Related guides

• AIF tax and compliance calendar
• SEBI AIF registration: steps and documents
• Our advisory services
• FEMA compliance for NRI founders
• About CA Vraj Changani