Pro-rata rights

Ten investors commit to a scheme. When the scheme buys into a company, whose money is it? And when that company is sold, who gets what?

The answer the SEBI (AIF) Regulations give is pro rata to commitments. An investor who committed 10% of the scheme is 10% of every investment and receives 10% of the proceeds. Nobody gets a better seat in one deal and a worse one in another.

The rule has a small number of named exceptions — an investor who sits a deal out, an investor who fails to pay, the manager's performance share, and a special junior class of units. Everything else is pro rata.

The rule was inserted by the SEBI (AIF) (Fifth Amendment) Regulations, 2024, with effect from 18 November 2024, with a SEBI circular of 16 December 2024 (Chapter 17, section 17.11.1).

The rule. Investors in an AIF scheme have rights pro rata to their commitments — in each investment of the scheme and in the distribution of proceeds of that investment — except as SEBI specifies.

Exceptions in an investment and its proceeds, to the extent that:

• an investor has been excused or excluded from participating in the investment; or
• an investor has defaulted on providing its pro-rata contribution.

Exception in distributions only: returns shared with the manager — performance fees or carried interest under the contribution agreement.

Junior or subordinate class. Named entities — the manager or sponsor, multilateral or bilateral development financial institutions, State Industrial Development Corporations, and government-owned or controlled entities including central banks and sovereign wealth funds — may subscribe to units that accept lesser returns or share excess losses compared with their pro-rata rights.

Old schemes. Rights in schemes issued before 18 November 2024 that are not pro rata and not exempted are dealt with as SEBI specifies. Schemes that adopted a priority distribution model with differential rights before that date may not accept fresh commitments or invest in a new investee company; any resulting breach of investment limits is recorded in the Compliance Test Report rather than treated as non-compliance.

Pari-passu, not identical. Differential rights may still be given to select investors, provided they create no liability for other investors, give no control over decisions (unless the investor is on the Investment Committee), do not alter other investors' rights, and are disclosed in the PPM with their eligibility criteria.

Pro rata elsewhere in the fund. Set-up costs are allocated pro rata to commitments; transaction expenses pro rata across classes of units; and in the distribution waterfall, net proceeds first repay investors' contributions pro rata, then pay the preferred return.

Investor share of an investment = Investor commitment / Commitments of all participating investors

Participating investors = all investors - excused - excluded - defaulting

Deccan Growth Fund I (illustrative) has commitments of Rs 200 crore:

The investment. The scheme invests Rs 40 crore in a company. Investor C is excused from this deal under the PPM's terms, so the Rs 40 crore is shared among commitments of Rs 180 crore.

The exit. The stake is sold for Rs 100 crore. The manager's carried interest under the contribution agreement is Rs 12 crore (illustrative). That share is outside the pro-rata rule; the remaining Rs 88 crore is not.

What the rule forbids: giving investor B, say, 25% of these proceeds because B negotiated a side letter — unless B holds a junior class that accepts less, which would move the other way.

Chapter 17 (Regulatory Framework), section 17.11.1 on pro-rata and pari-passu rights of investors is the source, with the junior-class list and the transition rules for priority distribution models. Chapter 9 applies pro-rata allocation to set-up costs, transaction expenses and the distribution waterfall. Expect a question on the exceptions to the pro-rata rule, on who may subscribe to a junior class, and on the effective date of 18 November 2024.

• Three exceptions for an investment: excused, excluded, defaulted. One more for distributions: performance fees or carried interest shared with the manager.
• Pro rata to commitments, not to amounts paid in so far and not to NAV.
• Junior units may accept less — lesser returns or excess losses. They are not a route to more.
• Priority distribution models adopted before 18 November 2024 freeze the scheme: no fresh commitments, no new investee companies.
• Differential rights are still allowed within the pari-passu principles — pro rata does not mean every investor has an identical document.
• Not the same as a pre-emptive right in an investee company, which lets a shareholder buy pro-rata shares in future funding rounds. That is an anti-dilution right at company level, not a fund-level rule.