Roll-up vehicles driving early-stage investments

Roll-up vehicles (RUVs) have gained significant traction in India, with the potential to revolutionise seed funding. An RUV is a special-purpose vehicle that melds many individual and limited-scale institutional investors into a single entity on the startup’s capital table. It is usually set up through a service provider responsible for the RUV’s formation and regulatory accreditation, the collection of capital from its participating investors, KYC compliance and the execution of the transaction documents for the investment round. RUVs are mostly managed by professional third-party firms.

The RUV structure is attractive to founders because smaller ticket sizes are bundled into one entity, reducing legal and administrative costs and saving the time that would otherwise have been spent in dealing with multiple investors, without losing diversity in the investor pool. An RUV simplifies the cap table of the company, making logistical co-ordination such as exercising voting and other shareholder rights far more efficient for the founders because they are collectively exercised through the RUV. Setting up an RUV can be cost-efficient because current RUV service providers only charge a nominal percentage of the deal size of around 2%. They may also charge a relatively small, fixed fee for providing end-to-end coordination and services on behalf of the participating angel investors as opposed to the carry and other fees usually applied to non-RUV managed funds.

Investors also benefit from using an RUV. Provided the aggregate investment in RUVs over five years is INR2.5 million (USD30,000) or more, an investor does not have to invest a set minimum in a single RUV. RUVs allow angel investors to more easily diversify their portfolios and invest in multiple entities over the five-year period. Additionally, RUV investments receive pass-through status with the investors subject to taxes as if they had directly invested and held shares in the investee entity. At the time of investor-payout, the RUV must withhold 10% against tax for domestic investors. Investors, however, can claim against such withholding amount during their income tax filings.

Investors do have some limitations to bear in mind. Participating investors should meet the criteria for angel investors under the SEBI (Alternative Investment Funds) Regulations, 2012. They must be serial entrepreneurs, senior management professionals with at least 10 years’ experience or have prior early-stage investment experience. Each investor should have net tangible assets of at least INR20 million, not including the value of their principal residence.

Investments through RUVs are locked for a minimum period of one year and no more than 200 angels can invest in an RUV. Lastly, participating investors cannot be relatives of persons who are promoters or directors of or have control over the investee entity. Subsidiaries, holding companies, companies that are part of the same group or management, or companies whose directors or partners control 15% or more of the shares or voting power in the investee entity are also excluded from investing through an RUV. RUVs themselves have to commit to a minimum of INR2.5 million and a maximum of INR100 million for each investment. The maximum investment by an RUV in an entity cannot exceed 25% of the total investments of all its schemes.

Investing through an RUV is not limited to domestic investors although RUV service providers tend to set higher requirements for foreign investors, which may include higher minimum investment thresholds in each investee entity.

Startups should consider the nature of the rights that may have to be offered to the RUV for its more sizeable stake, compared to the nominal rights otherwise offered to individual investors. Where foreign investors participate, startups should be mindful of the requirements under foreign exchange regulations including pricing and sectoral conditions. Investors should clearly decide from the beginning the manner in which the rights of the RUV in the investee entity are to be exercised. They should examine the ability to exit independently from others in the RUV and the tax impact of such an exit.

RUVs are becoming increasingly attractive because they provide start-ups with easy access to early-stage investment through a simple and cost-effective alternative vehicle. Whether or not RUVs continue on the cap table in mature investments is yet to be seen.

Swathi Girimaji is a partner and Sachit Ram is an associate at Bharucha & Partners.