Co-Investment Vehicle: Does it Drive the Point Home?

[Hemendra and Arzoo are students at Hidayatullah National Law University.]

On 9 May 2025, the Securities and Exchange Board of India (SEBI) issued a consultation paper suggesting a new co-investment framework under a specific co-investment vehicle (CIV) structure. This is intended to simplify and replace the current co-investment route regulated under the portfolio management services (PMS) model. While the proposed model seeks to resolve several operational and regulatory challenges in the current system, it also introduces new limitations and ambiguities that may hinder its practical efficacy. This article examines the structural shortcomings of the present co-investment framework, critically analyses the proposed CIV model, identifies persisting issues in SEBI’s new approach, and suggests a constructive way forward, informed by global best practices.

Structural Challenges in the Existing Co-investment Framework

As the nomenclature suggests, the term co-investment means investing alongside. In this context, co-investment refers to investing along with alternative investment funds (AIF), which are primary funds. The underlying factors for adopting this investment model by the manager of an AIF are to bridge the funding gap, capital efficiency, flexibility in deal structuring, and to attract institutional investors. On the other hand, investors opt for this investment model due to lower cost, greater control and decision making, and access to exclusive opportunities. 

This model is primarily governed by the SEBI (Alternative Investment Funds) Regulations 2012 and the SEBI (Portfolio Managers) Regulations 2020. Through these regulations, SEBI aims to regulate the co-investment model, but it still falls short of making an efficient ecosystem for the co-investors of AIFs because of significant operational clutter that is associated with the portfolio management services and special purpose vehicle routes, like high cost, limited liquidity, lack of transparency, and regulatory risks. 

To overcome these operational inefficiencies, SEBI has floated a consultation paper to replace the existing PMS route with a new co-investment vehicle route to facilitate co-investment alongside the main category-I or category-II AIFs as a separate schemes of the main AIF. 

What the proposed CIV model seeks to improve 

Co-investments in the current model must proceed via PMS institutions, necessitating a separate license for the AIF manager, duplicate compliance, and distinct exit and governance terms, cumbersome documentation, and a co-terminus timeline. This frequently makes deal execution and cap table administration more difficult. CIVs, on the other hand, would maintain co-investments within the AIF ecosystem, enabling swifter execution, consistent documentation, and pooled governance. Additionally, SEBI would discontinue the separate licensing requirement for the purpose of offering co-investment, and the proposed changes will resolve the cap table issue that is often confronted by certain portfolio companies. 

Furthermore, in the proposed system, foreign investors may co-invest in securities which they could not do directly under the current co-investment portfolio manager (CPM) structure due to foreign exchange restrictions. 

And perhaps one of the biggest advantages that the proposed model may bring is governance benefits. As CIV investors, co-investors have the ability to hold the fund manager jointly responsible. Smaller co-investing limited partners (LPs) may profit from the governance practices of larger co-investing LPs by being co-LPs in a single CIV as opposed to separately managed accounts (SMAs). However, CIV also causes certain governance problems, which are covered in the following section.

Persisting challenges in the proposed CIV model

Despite the proposed benefits, the reform introduces several limitations that may hinder the development of an efficient co-investment ecosystem. 

First, CIV is to be the scheme of a category I or category II AIF that is intended to facilitate the co-investment of the investors of any AIF scheme in unlisted securities. Here, the co-investment structure is restricted exclusively to the investors of the AIF scheme. There is a whole segment of potential investors who are desirous to be part of the co-investment structure, but are reluctant to be part of a blind pool structure ingrained in AIF. 

Further, SEBI seeks to offer co-investment opportunities through the CIV route exclusively to accredited investors, which may result in the exclusion of investors who do not meet the prescribed accreditation criteria. While this may not create a significant barrier for sovereign entities, category 1 foreign portfolio investors, accredited investment funds, and regulated financial institutions (who are deemed to be accredited), it could create critical challenges for HNIs, small institutional investors, retail investors, and emerging fund managers. 

SEBI has also proposed that the tenure of a CIV is to be co-terminus with that of the corresponding AIF. This mandate will lead to the compulsory termination of co-investors coming through the CIV route, as they would lack the option of remaining invested beyond the period of the main AIF or, in case it exits, then even sooner. This bars them from unlocking the true potential of the co-investment model. 

CIVs would also rely significantly on contractual agreements to specify the rights and responsibilities of co-investors. Because contractual clauses may be interpreted differently and may not have the same level of protection as statutory provisions, this reliance may result in ambiguity, particularly during disputes. Lack of explicit statutory requirements may make it difficult to enforce co-investor rights, which could result in drawn-out legal battles.

Another aspect to consider is that category I and category II AIFs in India have “pass-through” tax status, which prevents double taxation at the fund level by taxing the fund's revenue directly to investors. The entire structure may be taxed as a single company if tax authorities believe that a CIV and its AIFs' coordinated investments constitute an "association of persons". Taxation at the fund and investor levels would result from this classification, which would eliminate the pass-through benefits. It is yet to be seen whether CIVs will also enjoy the same tax benefits as AIFs.

Lastly, under the existing CPM structure, investors across all AIFs managed by the same sponsor can participate in co-investment opportunities. SEBI's new proposal introduces CIVs as separate schemes under a single AIF. This means co-investment opportunities would be limited to investors within a specific AIF scheme, rather than across multiple AIFs under common management. Additionally, this poses operational challenges as the CIVs would require separate PANs, demat accounts, and bank accounts. Additionally, because the current legal framework does not explicitly enable such configurations, AIFs constituted as LLPs or businesses may encounter operational and regulatory challenges when establishing numerous schemes. The flexibility and scalability that the new CIV model seeks to offer may be constrained by these complications. 

Way Forward 

The restrictive approach sought to be adopted by the SEBI with regard to investors' participation in CIVs other than the AIF schemes limits the scope of investment accessibility and capital formation. This approach is not on par with other jurisdictions that have co-investment models. In Singapore, the variable capital company framework allows the creation of segregated portfolios and allows the investors to co-invest in specific deals without committing anything to the blind pool. Similarly, in Hong Kong, the open-ended fund companies framework provides flexibility to the investors of private equity, allowing investors other than the AIF investors to participate in the co-investment structures. This flexible framework has enhanced capital mobilization, risk diversification, and strategic partnership, and enables cross-border investment in both jurisdictions, and helps both jurisdictions in evolving as preferred destinations for global investors. Driven by this flexible co-investment model, by 2027-28, the Hong Kong wealth management industry is expected to overtake Switzerland. 

Further, with the proposed framework, the pool of potential co-investors is reduced from all LPs to just those who hold CIV accredited investor status. Since the risks of being an LP in a single-asset fund, or worse, a single-asset fund-of-one, are not significantly higher than those of being subject to an SMA structure, this should be reversed. Additionally, restricting CIV to accredited investors only doesn’t serve the purpose for which accreditation was introduced. It was brought for the recognition of sophisticated investors who have financial capacity and expertise to engage in riskier investments. Alternatively, SEBI may adopt a tiered investors classification akin to Singapore, wherein non-accredited investors have access to private equity opportunities through a higher minimum investment threshold, thereby allowing the participation of HNIs, small institutional investors, and retail investors, while ensuring the appropriate safeguards. Additionally, even if it would have an impact on the capital structure, co-investments should be made available to third-party co-investors. 

SEBI in its consultation paper has also stated that co-terminus timelines are to be introduced with the objective to mitigate the conflict of interest between the manager, investors of AIF, and co-investors. It could however undermine the interests of co-investors because they may have the capacity to hold the investment beyond the period of the AIF, as AIFs have a definite term and have to exit within that time period. In lieu of that, SEBI may impose a lock-in period of 1 year for the co-investors in order to prevent short-term arbitrage, with an exemption of relaxed exit conditions like permitting an exit when an investee company goes for public listing, similar to a lock-in period imposed on the venture capital under the SEBI (Foreign Venture Capital Investor) Regulations 2000. 

Concluding Thoughts 

The SEBI-recommended CIV framework is a positive measure towards simplifying the co-investment regime by eradicating duplicative compliance requirements and allowing quicker execution. Nevertheless, its limited scope, restricting participation to existing AIF investors and accredited investors, may counteract the universal objective of democratizing access to private equity opportunities. Additionally, the co-terminus requirement, dependency on contractual protection, and tax-related risks may present operational and legal hurdles.

For the CIV model to fulfil its envisioned goals, SEBI might consider taking a more open and adaptable approach, learning from international models like Singapore's variable capital companies and Hong Kong's open-ended fund companies. Expanding investor access, providing longer investment horizons with protection, and simplifying the legal and tax status of CIVs will contribute to a healthy, open, and scalable co-investment market in India.