The most practical way for Indian HNIs to back startups is through SEBI-registered Alternative Investment Funds (AIFs)—primarily Category I (VC/Angel Funds) and, in later stages, Category II PE funds. Standard AIF tickets start at ₹1 crore (₹25 lakh for certain employees/directors), Angel Funds have lower per-deal thresholds, and Category I & II AIF income (other than business income) generally enjoys pass-through taxation to investors. India’s “angel tax” under Section 56(2)(viib) has been removed from 1 April 2025 for qualifying start-ups. (BCAS) (assets.cleartax-cdn.com) (ClearTax) (Startup India)
What this article covers
- How AIFs invest in Indian startups (fund types, stages, deal flow)
- Who can invest and minimum cheque sizes
- Tax treatment (Section 115UB pass-through, TDS mechanics, angel-tax status)
- Fees, timelines, and return metrics (IRR, TVPI, DPI)
- Risks, diligence checklist, and a 5-step decision framework
- 2025 regulatory updates affecting Angel Funds
AIFs 101: Where startups fit
SEBI recognises three AIF categories. For startup exposure, the most relevant are:
- Category I (Venture Capital/Angel Funds): Invest in early-stage/innovation-driven businesses. Often seed to Series A. (Securities and Exchange Board of India)
- Category II (PE/ Growth / Special Situations): Later-stage unlisted equity, growth rounds, and structured deals (no leverage except for operations). (Securities and Exchange Board of India)
- Category III (Hedge strategies): May trade listed securities/derivatives; not typically a pure “startup” sleeve and has different tax treatment. (Securities and Exchange Board of India)
Typical life cycle & cash flows
- Closed-end fund tenor: often 8–10 years with 2–3 years investment period.
- Capital calls: committed capital is drawn over time as deals close.
- Distributions: occur on exits (M&A, secondary, IPO; increasingly via strategic sales).
Who can invest & minimum tickets
- Minimum commitment to an AIF scheme: ₹1 crore per investor. Employees/directors of the AIF or its manager may invest ₹25 lakh. (BCAS)
- Angel Funds (a sub-type within Category I): historically invested ₹25 lakh–₹10 crore per startup; SEBI’s Board on 18 Jun 2025 approved lowering the floor to ₹10 lakh and raising the cap to ₹25 crore, plus other relaxations—to take effect after formal regulation amendments/notifications. Track status before investing. (Moneycontrol, Mondaq, Economic Laws Practice)
Note: Angel Funds are moving to an Accredited Investor–only participation model per the June 2025 Board decisions (post-notification). (Economic Laws Practice)
Taxation: what matters to you
Pass-through (Section 115UB):
- Category I & II AIFs: most income (other than business income) is taxed in investors’ hands, not at the fund (pass-through). Funds file Forms 64C/64D to report allocations. (ClearTax, Ebizfiling)
- Withholding/TDS mechanics: The payer to the AIF need not deduct TDS on income other than business income (Notification 51/2015 under Section 197A(1F)). The AIF deducts tax when passing income to investors (e.g., 10% for resident unit-holders). (assets.cleartax-cdn.com, Khaitan & Co)
- Category III AIFs: no pass-through in general; taxation is typically at the fund level (with special rules for IFSC “specified funds”). Consult your advisor for the exact rate path. (Nishith Desai Associates, ClearTax)
Angel tax is gone (for qualifying startups):
- Finance Act (No. 2) 2024 removed Section 56(2)(viib) (“angel tax”) effective 1 April 2025—a major boost to fundraising outcomes and valuation flexibility for DPIIT-recognised startups. (Startup India)
What returns look like (and how to read them)
AIFs usually report IRR, TVPI, and DPI:
- IRR (annualised): the discount rate that sets NPV of cash flows to zero.
- Conceptually: find r such that ∑ (Distributionsₜ − Callsₜ)/(1+r)ᵗ = 0.
- TVPI (Total Value to Paid-In): ∗∗(NAV+Distributions)÷Paid−InCapital∗∗**(NAV + Distributions) ÷ Paid-In Capital**
- DPI (Distributions to Paid-In): ∗∗RealisedCashReturned÷Paid−InCapital∗∗**Realised Cash Returned ÷ Paid-In Capital**
Illustration: You commit ₹1 crore. The fund calls ₹25 lakh at T0, ₹25 lakh at T1, and ₹50 lakh at T2. By T6 it distributes ₹1.6 crore.
- Paid-In = ₹1.0 cr, Distributions = ₹1.6 cr, assume NAV = 0 → TVPI = 1.6×, DPI = 1.6×.
- If distributions arrived late (T6–T9), IRR could be modest despite a high multiple—the “J-curve” effect.
Costs & structures you should expect
- Management fee: typically 1.5%–2.5% p.a. on committed or drawn capital.
- Carry (performance fee): often 20% over an 8% hurdle, with catch-up; waterfalls vary.
- Set-up & admin: legal, audit, custodian, and fund administration costs are common.
- Side letters & co-investments: larger investors may negotiate economics/rights; SEBI has tightened disclosures and standardisation in recent circulars (PPM benchmarking, side-letter parity themes—check the scheme PPM).
(Fee numbers are market conventions, not regulated caps; read your PPM.)
Where AIFs find deals (India-first examples)
- Digital infra & SaaS: B2B software, developer tools exporting to the US/EU.
- Fintech & embedded finance: NBFC tech, credit analytics (mindful of RBI guidelines).
- Climate & EV supply chain: battery materials recycling, grid software.
- Healthtech: diagnostics SaaS, med-devices.
- Agritech: precision input marketplaces, cold-chain IoT.
AIFs typically lead or follow seed to Series B rounds, anchor converts/SAFE-like instruments, and run portfolio value-addition (hiring, GTM partnerships, governance).
Key risks (and how to mitigate)
- Illiquidity: 7–10 year lock-ups; secondary sales are uncertain.
- Blind-pool risk: you commit before the full deal list exists—evaluate the GP’s prior DPI, not just TVPI.
- Concentration: early-stage outcomes are power-law distributed—ensure the fund targets 20–30+ names for true diversification.
- Valuation & down rounds: macro cycles can compress multiples; insist on pro-rata rights and follow-on reserves.
- Regulatory drift: watch Angel Fund rule changes from Jun-2025 and AIF tax clarifications (especially for Category III and IFSC). (Economic Laws Practice, Nishith Desai Associates)
Due-diligence checklist (print-friendly)
- Team & governance: Partner time on seed, IC process, conflicts policy, key-man clause.
- Track record: Realised DPI by vintage, loss ratio, follow-on rates.
- Portfolio construction: target ownership, cheque sizes, follow-on reserve %, sector and stage mix.
- Economics: fee basis (committed vs drawn), hurdle, catch-up, clawback, escrow.
- Operations: auditor, custodian, admin, valuation policy (Ind-AS/IFRS alignment).
- Compliance: SEBI registration no., PPM version, side-letter policy, KMP experience.
- Tax: reporting (Forms 64C/64D), TDS handling, NR/IFSC nuances. (Ebizfiling)
AIFs vs direct angeling vs syndicates (at a glance)
| Route | Min ticket | Effort | Diversification | Access | Tax handling |
|---|---|---|---|---|---|
| AIF (Cat I VC) | ₹1 crore (std) | Low–medium | High (pooled) | Strong GP deal-flow | Pass-through (115UB)* |
| Angel Fund (Cat I – Angel) | Lower per-deal cheques; floor trending ₹10L post-notification | Medium | Medium–high | Curated early-stage | Pass-through* |
| Direct angels/syndicates | From ₹5–25L typical | High | Low unless many deals | Variable | Personal compliance |
* Income other than business income; see Section 115UB and scheme PPM. (ClearTax)
5-step framework to decide your allocation
- Define role in your plan: Treat startup AIFs as a satellite/alpha sleeve (e.g., 5–10% of net financials for HNIs), not core liquidity.
- Pick vintage & pacing: Prefer vintage diversification (multiple funds across 2–3 years).
- Underwrite the GP: Prior distributions, realised exits in India, and follow-on support track record.
- Model cash flows: Expect calls in the first 2–3 years; use DPI-centric scenarios (base 1.2×, target 2×+).
- Close on terms: Negotiate co-invest rights, MFN side-letter language, and reporting cadence.
2025 Regulatory updates you should know
- Angel Fund revamp (Board decisions, 18 Jun 2025): Lower per-deal floor to ₹10 lakh and raise cap to ₹25 crore, removal of 25% concentration cap, ability to include >200 accredited investors per investment, and follow-ons even after a company ceases to be a “startup”. Implementation awaits formal SEBI amendments/notifications—verify current status. (Moneycontrol, https://www.taxmann.com, Economic Laws Practice)
- Angel tax removal (from 1 Apr 2025): Section 56(2)(viib) deleted—DPIIT-recognised startups can raise at FMV without angel-tax friction. (Startup India)
FAQs
Q. What is the minimum I can invest to access startup deals via AIFs?
A. Standard AIF commitments start at ₹1 crore (₹25 lakh for certain employees/directors). Angel Funds operate per-deal minima and are moving toward a ₹10 lakh floor (post-notification). (BCAS, Moneycontrol)
Q. How am I taxed?
A. In Category I & II AIFs, most income is passed through and taxed in your hands; the fund reports via Forms 64C/64D. Category III generally taxes at fund level. (ClearTax, Ebizfiling, Nishith Desai Associates)
Q. Is TDS deducted before I receive distributions?
A. Payers to the AIF don’t deduct TDS on non-business income (per Notification 51/2015), but the AIF withholds when distributing to you (e.g., 10% for residents). (assets.cleartax-cdn.com, Khaitan & Co)
Q. What risks are unique to startup AIFs?
A. Illiquidity, power-law outcomes, vintage cyclicality, and regulatory changes (e.g., Angel Fund rules) are key. Diversify across vintages and managers. (Economic Laws Practice)
Bottom line
For most HNIs and family offices, Category I VC/Angel AIFs offer the cleanest, compliant path to participate in India’s startup upside with pass-through tax efficiency and professional portfolio construction. Anchor on GP quality and realised DPI, diversify across vintages, and track the 2025 Angel Fund rule amendments before wiring capital. (ClearTax, Moneycontrol)