SEBI Co-Investment Schemes Framework: Transforming Alternative Investment Landscape in India

Introduction

The Securities and Exchange Board of India (SEBI) has introduced a transformative regulatory framework through the SEBI (Alternative Investment Funds) (Second Amendment) Regulations 2025, which marks a significant evolution in India’s alternative investment ecosystem. This amendment introduces SEBI co-investment schemes within the Alternative Investment Funds (AIFs) framework, creating new opportunities for investors while maintaining robust regulatory oversight. The development represents a carefully calibrated approach to enhance market efficiency while protecting investor interests, a balance that has defined SEBI’s regulatory philosophy since its inception.

Understanding the Alternative Investment Funds Regulatory Framework

The journey of alternative investments in India began with the SEBI (Alternative Investment Funds) Regulations 2012, which came into force on May 21, 2012 [1]. These regulations replaced the earlier SEBI (Venture Capital Funds) Regulations 1996, creating a unified regulatory framework for all non-traditional investment vehicles. The 2012 regulations established AIFs as privately pooled investment vehicles that collect funds from investors, whether Indian or foreign, for investing according to a defined investment policy for the benefit of their investors.

The regulatory framework divides AIFs into three distinct categories, each serving different investment objectives and risk profiles. Category I AIFs include venture capital funds, infrastructure funds, social venture funds, and SME funds, which invest in start-ups, early-stage ventures, social enterprises, and infrastructure sectors. These funds receive certain incentives from the government due to their positive impact on the economy and employment generation. Category II AIFs encompass private equity funds, debt funds, and fund of funds that do not fall under Category I or Category III, operating without leverage except for meeting day-to-day operational requirements. Category III AIFs employ diverse or complex trading strategies and may use leverage, including hedge funds and trading-oriented funds.

The regulatory architecture established in 2012 set minimum investment requirements, disclosure obligations, and operational guidelines that have shaped the growth trajectory of India’s alternative investment sector. Over the years, SEBI has demonstrated a dynamic approach to regulation, periodically amending these rules to address emerging market needs while maintaining investor protection standards.

The Genesis of Co-Investment Schemes 

Prior to the 2025 amendment, co-investment arrangements existed in a limited form through the Centralized Portfolio Management System (CPMS) route, which allowed portfolio managers to facilitate co-investments [2]. However, this mechanism had inherent limitations that restricted its utility for both fund managers and investors. The existing framework lacked clarity on governance structures, operational procedures, and regulatory compliance requirements specific to co-investment arrangements.

Co-investment, in its fundamental essence, represents an arrangement where investors in an AIF participate directly in specific investment opportunities alongside the main fund. This structure offers several advantages including enhanced capital deployment flexibility, reduced fee burden for investors on co-invested amounts, and improved alignment of interests between fund managers and investors. However, the absence of explicit regulatory recognition created uncertainty around permissibility, documentation requirements, and compliance obligations.

The introduction of dedicated co-investment schemes through the 2025 amendment addresses these gaps systematically. Under the amended regulations, co-investment is formally defined as investments made by managers, sponsors, or investors of Category I or Category II AIFs in unlisted securities of investee companies where the fund also makes investments [3]. This definition brings clarity to what constitutes permissible co-investment activity and establishes boundaries for regulatory oversight.

Key Features of the New Co-Investment Framework

The amended regulations introduce several critical features that define the operational contours of co-investment schemes under SEBI. The framework restricts participation to accredited investors of Category I and Category II AIFs, ensuring that only sophisticated investors who understand the risks and complexities of such arrangements can participate. This restriction aligns with SEBI’s broader philosophy of graduated investor protection based on investor sophistication and financial capacity.

Each co-investment scheme is permitted to invest in only one investee company, a restriction designed to maintain transparency and avoid commingling of investments across multiple opportunities. This single-company limitation ensures that investors have complete clarity about where their co-investment capital is deployed and can make informed decisions based on the specific merits of each investment opportunity. The scheme cannot invest in units of other AIFs, maintaining a clear separation between primary fund investments and co-investment arrangements.

The shelf placement memorandum emerges as the cornerstone document for co-investment schemes [4]. This memorandum must contain principal terms relating to co-investments, including the governance structure, regulatory framework, investment strategy, and risk factors. The document serves as the primary disclosure mechanism through which fund managers communicate the essential features of the co-investment opportunity to potential participants. The memorandum approach provides flexibility while ensuring adequate disclosure, allowing managers to structure co-investment opportunities efficiently without repetitive documentation requirements for each specific opportunity.

Governance and Operational Requirements

The governance architecture established by the regulations ensures proper segregation and management of co-investment schemes. Each scheme must maintain separate bank accounts and demat accounts, creating a clear financial and securities holding separation from the parent AIF and other schemes [5]. This segregation serves multiple purposes including facilitating accurate accounting, preventing commingling of assets, and enabling clear audit trails for regulatory compliance and investor reporting.

The concept of ring-fencing assumes particular importance in the co-investment context. All assets held under a co-investment scheme remain insulated from the assets of other schemes and the parent fund. This legal and operational separation protects co-investors from risks associated with other schemes or the parent fund’s portfolio, ensuring that each co-investment stands on its own merits and risks. The ring-fencing also simplifies exit and liquidation processes, as each scheme’s assets can be dealt with independently.

Investment limits form another crucial aspect of the governance framework. The regulations stipulate that co-investment in an investee company cannot exceed three times the contribution of an investor in that company, unless the co-investment is made through specific financial institutions [6]. This provision prevents excessive concentration and ensures that co-investment remains supplementary to the main fund’s investment rather than becoming the primary deployment mechanism. The three-times limit balances the objectives of providing flexibility for larger co-investment tickets while preventing potential abuse or excessive concentration risks.

Compliance and Regulatory Safeguards

The regulatory framework incorporates several compliance requirements designed to prevent circumvention of securities laws and maintain market integrity. Fund managers bear the responsibility of ensuring that investors do not hold stakes indirectly through co-investment that they would be prohibited from holding directly. This provision addresses potential regulatory arbitrage where investors might use the co-investment structure to bypass direct investment restrictions or limitations applicable to them under other regulations.

The regulations also mandate that managers ensure no investment is made through co-investment schemes that would trigger additional disclosure requirements if made directly by the investor. This requirement maintains the integrity of disclosure regimes under various securities laws and prevents the co-investment structure from becoming a mechanism to avoid transparency obligations. For instance, if an investor’s direct investment would trigger public shareholding disclosure requirements under takeover regulations, the co-investment route cannot be used to circumvent such requirements.

An important safeguard addresses the prevention of fund flow from prohibited sources. The regulations require managers to ensure that no investee company receives funds from an investor who is otherwise restricted or prohibited from making such investments [7]. This provision is particularly relevant in the context of foreign investment regulations, where certain sectors have restrictions on the nature and source of investments. The co-investment structure cannot become a conduit for circumventing such sectoral restrictions or source-based limitations.

Cost Sharing and Economic Arrangements

The treatment of expenses associated with co-investment arrangements reflects principles of fairness and proportionality. The regulations mandate that expenses incurred in making co-investments must be shared proportionately between the AIF and the co-investment scheme based on the ratio of their respective investments [8]. This provision ensures that neither the main fund investors nor the co-investors bear a disproportionate expense burden relative to their investment quantum.

The expense-sharing mechanism addresses a practical challenge that has characterized co-investment arrangements globally. Deal sourcing, due diligence, legal documentation, and transaction execution involve significant costs. The proportionate sharing principle ensures that these costs are allocated fairly, preventing situations where either party subsidizes the other’s investment. This clarity on cost allocation enhances transparency and reduces potential disputes between fund managers, main fund investors, and co-investors.

The regulations leave certain aspects of economic arrangements to contractual negotiations between parties, subject to disclosure in the shelf placement memorandum. These include carry arrangements, management fee structures for co-investment schemes, and preferred return mechanisms. This flexibility allows fund managers to structure economically viable co-investment opportunities while ensuring full disclosure to participants.

Penalties and Enforcement Mechanisms

The regulatory framework incorporates penalty provisions to ensure compliance and deter potential violations. A significant provision addresses investor defaults in contribution commitments. Where an investor has defaulted on their contribution obligation, that investor is barred from participating in co-investment in the relevant investee company [9]. This penalty serves as a strong deterrent against commitment defaults while protecting the interests of other investors and the investee company who rely on committed capital being deployed as agreed.

The default penalty reflects broader principles of commercial discipline and contract sanctity. Co-investment arrangements involve commitments to deploy capital at specified times or upon occurrence of specified conditions. Default by one investor can impact the entire investment structure, potentially causing losses to the fund, other investors, and the investee company. The exclusion penalty ensures that defaulting investors cannot enjoy the benefits of co-investment opportunities while failing to honor their obligations.

Beyond the specific default penalty, co-investment schemes remain subject to SEBI’s broader enforcement framework under the AIF Regulations. This includes adjudication and penalty provisions for various violations, consent mechanisms for settling proceedings, and appellate procedures. Fund managers operating co-investment schemes must ensure compliance not only with the specific co-investment provisions but also with general AIF obligations regarding registration, reporting, disclosure, and conduct standards.

Regulatory Evolution and Market Development

The introduction of co-investment schemes represents part of SEBI’s broader strategy to develop alternative investment markets in India while maintaining appropriate regulatory safeguards. The alternative investment sector has grown substantially since 2012, with assets under management increasing from modest levels to becoming a significant component of India’s financial landscape. This growth has been accompanied by increasing sophistication among investors, fund managers, and investee companies, creating conditions conducive to more flexible investment structures like co-investments.

SEBI’s approach to introducing co-investment schemes demonstrates regulatory pragmatism. Rather than imposing rigid structures, the regulations establish broad principles and essential safeguards while allowing flexibility in operational details. The shelf placement memorandum approach, in particular, exemplifies this balance between regulatory oversight and operational flexibility. Fund managers can structure schemes to meet specific opportunity requirements while ensuring adequate disclosure and investor protection.

The timing of the co-investment framework introduction aligns with several market developments. Increasing deal sizes in private equity and venture capital transactions often strain individual fund capacities, making co-investment attractive for deploying larger tickets. Growing investor sophistication has created demand for more flexible participation options beyond traditional fund structures. The success of co-investment arrangements in mature markets like the United States and Europe has demonstrated the viability and benefits of such structures, providing a template that Indian regulations have adapted to local conditions.

International Comparisons and Best Practices

While India’s co-investment framework is tailored to local market conditions and regulatory philosophy, examining international approaches provides useful context. In the United States, co-investment arrangements have become standard practice in private equity and venture capital, governed primarily by contractual arrangements between fund managers and investors, with regulatory oversight focused on ensuring adequate disclosure and preventing conflicts of interest. The Securities and Exchange Commission has provided guidance on when co-investment opportunities must be offered to all investors versus when they can be selectively offered based on investor capacity and interest.

European markets have seen co-investment structures flourish under the Alternative Investment Fund Managers Directive (AIFMD) framework, which establishes broad principles for investor protection while leaving operational details to member state implementation and contractual arrangements. The European approach emphasizes disclosure, conflict management, and ensuring fair treatment of all investors, principles that resonate with SEBI’s framework.

Singapore’s co-investment landscape operates under the regulatory oversight of the Monetary Authority of Singapore, which has adopted a principles-based approach similar to India’s current framework. The emphasis on accredited investor participation, adequate disclosure, and alignment of interests characterizes Singapore’s approach, reflecting recognition that sophisticated investors can evaluate and assume the risks associated with co-investment structures.

Implications for Fund Managers

For fund managers, the new co-investment framework presents both opportunities and operational challenges. The ability to offer co-investment opportunities enhances fundraising prospects, as many institutional investors actively seek such opportunities to deploy larger capital amounts in attractive opportunities while managing overall fund concentration. Co-investment capabilities have become a competitive differentiator among fund managers, and the regulatory clarity provided by the 2025 amendment enables Indian managers to compete more effectively with international peers.

However, implementing co-investment schemes under SEBI requires significant operational infrastructure. Fund managers must establish processes for identifying appropriate co-investment opportunities, marketing these to qualified investors, managing the shelf placement memorandum disclosure process, maintaining separate accounting and reporting systems for each scheme, and ensuring compliance with all regulatory requirements including the restrictions on indirect holdings and disclosure triggering. The requirement to ensure proportionate expense allocation adds complexity to financial management systems.

The governance responsibilities imposed on managers under the co-investment framework are substantial. Managers must actively monitor to ensure that co-investment structures are not used to circumvent applicable regulations, that investors honor their commitments, and that all disclosure obligations are met. These responsibilities create potential liability exposure that managers must carefully manage through robust compliance systems, appropriate insurance coverage, and clear contractual terms with investors.

Impact on Investors

For investors, particularly institutional investors like pension funds, insurance companies, and endowments, the formalization of co-investment schemes offers significant advantages. Co-investment opportunities enable larger deployment in attractive opportunities without the concentration risks associated with investing more in the main fund. The ability to selectively participate in specific opportunities allows investors to apply their own investment judgment and sector expertise to individual deals.

The fee advantages of co-investment are particularly attractive. Typically, co-investments are made without paying management fees or carried interest on the co-invested amount, or with reduced fees compared to main fund investments. Over the lifetime of investments, these fee savings can substantially enhance net returns to investors. For large institutional investors managing billions in assets, even modest fee reductions translate into significant absolute savings.

However, co-investment also requires investors to develop capabilities for evaluating individual opportunities, often within compressed timeframes. Unlike main fund investments where the fund manager conducts diligence and makes investment decisions, co-investment requires investors to independently assess opportunities and make timely commitment decisions. This necessity has led many institutional investors to build dedicated co-investment evaluation teams with sector expertise and deal execution capabilities.

Future Directions and Potential Refinements

As the co-investment framework becomes operational and market participants gain experience with its provisions, several areas may warrant future regulatory attention. The restriction limiting each scheme to one investee company, while providing clarity and transparency, may prove operationally cumbersome if investors wish to make multiple co-investments alongside the same fund. Future refinements might consider allowing schemes to invest in multiple companies while maintaining appropriate segregation and disclosure mechanisms.

The three-times investment limit, though designed to prevent excessive concentration, may be restrictive in certain circumstances where investee companies require larger capital infusions and investors have both the capacity and willingness to deploy more significant amounts. Regulatory consideration of higher limits under specified conditions or for certain categories of investors might enhance the framework’s flexibility without compromising its protective objectives.

The expense allocation methodology, while establishing the principle of proportionate sharing, leaves several practical implementation questions that may benefit from further guidance. Questions around allocation of expenses that benefit both main fund and co-investment differently, treatment of aborted transaction costs, and timing of expense recognition could be addressed through illustrative examples or clarificatory circulars as practical experience accumulates.

Conclusion

The introduction of co-investment schemes under the SEBI (Alternative Investment Funds) (Second Amendment) Regulations 2025 represents a significant advancement in India’s alternative investment regulatory framework. By providing explicit recognition and a structured framework for co-investment arrangements, SEBI has addressed a market need while maintaining robust investor protection standards. The framework balances flexibility in structuring arrangements with essential safeguards around governance, disclosure, and compliance.

The success of this initiative will depend on effective implementation by fund managers and constructive participation by investors. As market participants gain experience with the framework, best practices will emerge that enhance the efficiency and attractiveness of co-investment opportunities. Regulatory monitoring and periodic refinements based on practical experience will ensure that the framework continues serving its objectives of promoting market development while protecting investor interests.

For India’s alternative investment ecosystem, the co-investment framework opens new possibilities for capital deployment, investor engagement, and deal structuring. As the market matures and participants leverage these opportunities, co-investment has the potential to become a standard feature of alternative investment transactions, contributing to the depth and sophistication of India’s capital markets. The regulatory clarity provided by the 2025 amendment establishes the foundation for this evolution, positioning India’s alternative investment sector for continued growth and development.

References

[1] Securities and Exchange Board of India (Alternative Investment Funds) Regulations, 2012. Available at: https://www.sebi.gov.in/legal/regulations/aug-2024/securities-and-exchange-board-of-india-alternative-investment-funds-regulations-2012-last-amended-on-august-06-2024-_85618.html 

[2] Vinod Kothari Consultants. (2025). CIV-ilizing Co-investments: SEBI’s new framework for Co-investments under AIF Regulations. Available at: https://vinodkothari.com/2025/09/civ-ilizing-co-investments/ 

[3] TaxGuru. (2025). SEBI (Alternative Investment Funds) (Second Amendment) Regulations, 2025. Available at: https://taxguru.in/sebi/sebi-alternative-investment-funds-second-amendment-regulations-2025.html 

[4] Cyril Amarchand Mangaldas. (2025). Beyond CPMS Route: SEBI Unlocks Co-Investment Schemes for AIFs. India Corporate Law. Available at: https://corporate.cyrilamarchandblogs.com/2025/09/beyond-cpms-route-sebi-unlocks-co-investment-schemes-for-aifs/ 

[5] StudyCafe. (2025). SEBI Notifies Second Amendment to AIF Regulations, 2025: Introduction of Co-Investment Schemes. Available at: https://studycafe.in/sebi-notifies-second-amendment-to-aif-regulations-2025-introduction-of-co-investment-schemes-392931.html 

[6] TaxScan. (2025). SEBI Notifies Amendments to Alternative Investment Funds Regulations, 2012. Available at: https://www.taxscan.in/top-stories/sebi-notifies-amendments-to-alternative-investment-funds-regulations-1432258