PPM and LPA Drafting for AIFs: SEBI Mandatory Disclosures, Co-Investment Rights, and the Key-Man Clause

What SEBI Requires: The PPM and LPA Framework

Alternative Investment Funds (AIFs) regulated under SEBI's AIF Regulations, 2012 must prepare two critical documents: the Private Placement Memorandum (PPM) and the Limited Partnership Agreement (LPA). The PPM is the sales document; the LPA is the operative governing document. Both must comply with SEBI's mandatory disclosure norms, and neither is optional or purely contractual.

Under the AIF Regulations, 2012, SEBI mandates that the PPM contain all material information about the fund, its investment strategy, risks, fees, and the fund manager's background. The LPA must articulate the rights, obligations, and protections of investors (Limited Partners) and the manager (General Partner). Non-compliance here does not merely invite legal challenge--it invites regulatory enforcement action and can trigger de-recognition of the fund.

Mandatory Disclosures: What You Must Include

SEBI does not publish a tick-box PPM template. Instead, SEBI Circular No. CIR/IFD/AIF/2/2015 and subsequent amendments set out what must be disclosed. Your PPM must cover:

• Fund Objective and Strategy: Clear articulation of investment approach, asset classes, geography, and target returns. Vague language like "value creation" or "long-term appreciation" alone will not satisfy investors or SEBI.
• Investment Restrictions and Limits: How much can be invested in a single asset? What are sector caps? What is leverage permitted? This must align with the AIF's category (Category I, II, or III).
• Fee Structure: Explicit statement of management fees, performance fees (if any), and ancillary charges. The all-in cost to the investor must be transparent.
• Fund Manager Track Record: A detailed resume of the fund manager, investment team, and their prior fund performance (if any). This is where SEBI scrutinises exaggeration.
• Risk Factors: A candid section on market risk, concentration risk, liquidity risk, counterparty risk, and regulatory risk. Do not minimise or gloss over.
• Conflict of Interest: Disclose if the fund manager or any related party invests alongside the fund, manages competing funds, or has other material conflicts.
• Valuation and Reporting: How will assets be valued? How frequently will statements be sent to investors? What is the audit and assurance process?
• Use of Proceeds: If the fund is raising capital, how will it be deployed? Any cash drag or interim investment strategy must be outlined.

Missing or inadequate disclosures have led to SEBI show-cause notices, fund suspension, and, in severe cases, cancellation of AIF registration.

Co-Investment Rights: A Sticky Clause

Co-investment--where the fund manager invests its own capital alongside investor capital in the same deal--is a powerful alignment tool. However, it is also a lightning rod for conflict-of-interest disputes.

Your LPA must specify:

• Co-Investment Proportion: Will the manager invest pari passu (equal proportion) with investors, or a fixed amount?
• Co-Investment Terms: Will the manager's capital be subject to the same fee structure? If not, why not? Transparency here is critical.
• Clawback Rights: If the fund underperforms and performance fees are clawed back, does the manager's co-investment also suffer clawback, or is it protected? Most LPAs carve out the manager's co-investment from clawback, which is legitimate but must be disclosed.
• Entry and Exit Timing: Can the manager co-invest late in the fund's life or exit early? These asymmetries must be spelled out.

SEBI does not prohibit co-investment, but it demands transparency. An opaque co-investment clause that hints the manager may benefit disproportionately is a red flag for investor litigation and regulatory scrutiny.

The Key-Man Clause: The Regulatory Flashpoint

The key-man clause is perhaps the most contentious provision in an AIF LPA. It allows the fund to temporarily freeze capital calls if the named key individual (usually the fund founder or lead portfolio manager) departs or becomes incapacitated. The rationale: investors rely on this person's skill and judgment; if they leave, the fund's strategy and performance outlook change materially.

However, SEBI and investor advocates have flagged several risks:

• Indefinite Suspension: An overly broad key-man clause can allow the manager to suspend capital calls for months, trapping investor capital. This is unfair if the manager has not adequately back-filled the key person's role.
• Succession Planning Failure: A robust LPA should require the manager to have a documented succession plan and transition process. If the key person leaves and there is no succession plan, the key-man clause becomes an admission of poor governance.
• Investor Redemption vs. Lock-In: Some LPAs permit investors to redeem their commitment if the key-man clause is triggered. However, if the fund is illiquid, redemption is meaningless. The tension must be resolved clearly.

Best practice: Define the key-man clause narrowly (e.g., "if Founder ceases to actively manage at least 60% of the fund's portfolio for more than 90 days"). Couple it with a mandatory succession plan audit and set a firm deadline for capital call resumption (typically 180-365 days).

Common Drafting Pitfalls CAs Flag

• Inconsistency Between PPM and LPA: The fee structure in the PPM must match the LPA. Investors spot discrepancies instantly, and SEBI will too.
• Circular Cross-References: If your PPM says "refer to the LPA for details," but the LPA says "refer to the PPM," you have created ambiguity. Avoid.
• Governing Law and Dispute Resolution: Ensure the choice of law (typically Indian law for domestic AIFs) and arbitration venue are consistent across documents.
• Related Party Transactions: If the fund will transact with the manager or its affiliates, this must be disclosed upfront and, for material transactions, pre-approved by an independent committee.

Final Takeaway

PPM and LPA drafting for AIFs is not a commoditised exercise. SEBI's principles-based regulatory approach demands judgment, candour, and alignment of incentives. A sloppy document invites investor disputes, redemptions, and regulatory action. A well-drafted PPM and LPA protect the manager, reassure investors, and demonstrate professional governance.

I'm CA Harun Raaj, Visakhapatnam. If you're launching or managing an AIF and need guidance on PPM and LPA compliance, reach out.

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