Set-up Cost
Also written Set-up costs · Setup cost · Organizational expenses · Organisational expenses
The one-time cost of forming the fund and issuing its units, charged to investors as a percentage of capital commitments — up to 1.5% or 2.5% — and usually amortised over the first 36 months.
In plain language
Before a fund owns anything it has already spent money: drafting the PPM, registering with SEBI, paying lawyers, accountants and intermediaries, printing, compliance. That bill is the set-up cost, and the manager can charge it, once, to the unit-holders.
It is charged as a percentage of total capital commitments, which is worth pausing on. Not of NAV, not of invested capital — of what investors promised. An investor who commits Rs 5 crore pays set-up cost on Rs 5 crore from day one, whether or not a rupee has been drawn down.
How it works
The Investment Manager charges a one-time set-up cost from unit-holders as a percentage of their total capital commitments, which can go up to 1.5 percent or 2.5 percent of the total commitments raised by the fund. The costs cover offering costs, drafting of the PPM, registration and compliance costs, and fees and commissions paid to intermediaries or professionals, increased by GST and other applicable statutory taxes. Chapter 7 adds the flavour: external legal and accounting expenses, statutory compliance costs, directors' fees, printing costs and reasonable out-of-pocket expenses incurred by the investment management team.
Amortisation. Such set-up costs can be amortised over the first 36 months (or as defined in the PPM), or over the entire life of the AIF, commencing from the date of First Closing. They are allocated pro-rata to all investors on total capital commitments.
It helps to see the three expense buckets side by side, because questions mix them up deliberately:
| Bucket | Base | Limit |
|---|---|---|
| Set-up cost | total capital commitments | one-time, up to 1.5% or 2.5% |
| Operating expenses | NAV or capital commitments, whichever is higher | typically 10–50 basis points, yearly |
| Transaction expenses | actuals | no limit — brokerage, depository, custodian transaction charges, STT, exchange charges |
And one line that is never chargeable: the function of investment management is performed by the manager, so lease or rental charges, office maintenance, travel, outsourced support services, investment due diligence and transaction documentation costs for deal execution are borne by the manager and cannot be charged to the fund.
A worked example
Aravalli India Fund II, a Category II AIF, holds its first close on 1 April with total capital commitments of Rs 500 crore. The PPM provides for a set-up cost of 2% of commitments, amortised over 36 months.
Set-up cost 2% x Rs 500 crore Rs 10.00 crore
Add: GST at 18% Rs 1.80 crore
Total charged to investors Rs 11.80 crore
Amortised over 36 months Rs 3.93 crore per year
Ms Rao commits Rs 5 crore — 1% of the corpus — so she bears Rs 11.8 lakh of it, about Rs 3.93 lakh a year for three years, beginning at first closing.
Set that against the rest of the drag on her money in year 1:
| Charge | Amount on her Rs 5 crore |
|---|---|
| Set-up cost, amortised | Rs 3.93 lakh |
| Management fee at 1.75% on commitment, plus GST | Rs 10.32 lakh |
| Share of operating expenses at 30 bps | Rs 1.50 lakh |
| Year 1 total | Rs 15.75 lakh — 3.15% of her commitment |
The fund has to make that back before she is even level. It is also why the initial drawdown after first closing typically provides for management fees, organisational and other expenses attributable to the fund, and only then capital for investments.
Why NISM asks about it
Chapter 7 section 7.1.11.3 and Chapter 9 section 9.1 both carry it, and Section XII of the PPM — the illustration of fees, expenses and other charges — shows it year by year over the fund's life. Expect a computation with GST on top, a question on the 36-month amortisation from first closing, and a sorting question on which costs may be charged to the fund at all.
Common exam traps
- Charged on commitments, not on NAV or on invested capital — and one time, not annually.
- GST sits on top. A 2% set-up cost is 2.36% of commitments once tax is added.
- Amortisation runs from the date of first closing, over 36 months or as the PPM defines, or over the fund's whole life. It is not automatically the fund tenure.
- The manager's own costs are never chargeable — rent, office maintenance, travel, outsourced support, investment due diligence and deal documentation.
- Operating expenses are the recurring bucket, roughly 10–50 bps a year on NAV or commitments whichever is higher; transaction expenses are on actuals with no limit.
- Investors negotiate a cap per expense head — trusteeship fees, professional fees, administration, out-of-pocket costs, third-party fees — and the best outcome is netting them off against management fee already paid.
Check yourself
1.Which statement about an AIF's expenses is correct?
- a)Operating expenses and transaction expenses are both capped at 10 to 50 basis points
- b)Operating expenses are subject to a yearly limit of about 10 to 50 basis points on NAV or capital commitments whichever is higher, while transaction expenses are borne on actual basis only, without any limits
- c)Transaction expenses are capped but operating expenses are not
- d)Set-up costs must be expensed entirely in the first year
Show the answer
Answer: (b) Operating expenses are subject to a yearly limit of about 10 to 50 basis points on NAV or capital commitments whichever is higher, while transaction expenses are borne on actual basis only, without any limits
Two different regimes. Operating Expenses: typically, these are recurring expenses of the fund which the fund would charge to all investors as a whole and are subject to some limit like 10-50 basis points charged on the Net Asset Value or the capital commitments of the firms, whichever is higher. This limit is yearly. But: an AIF shall bear and pay all transaction expenses on actual basis only, without any limits, in relation to buying, selling or disposal of Investments — brokerage, depository charges, custodian transaction charges, securities transaction taxes and exchange charges. Option (d) is wrong because such Set-up Costs can be amortized over the first 36 months (or as defined in PPM), or the entire life of the AIF, commencing from the date of First Closing of the fund.
2.A Category II AIF manager wants to charge the fund for the following: office rent in BKC, a Big Four firm's financial due diligence on a target company, and the team's travel to meet portfolio companies. Can these be charged to the fund?
- a)Yes, all three are legitimate fund expenses
- b)No — all three are investment management functions whose costs must be borne by the manager and cannot be charged to the fund
- c)Only the due diligence cost may be charged, since it relates to a specific investment
- d)They may be charged only if the PPM discloses them
Show the answer
Answer: (b) No — all three are investment management functions whose costs must be borne by the manager and cannot be charged to the fund
The function of investment management is performed by the investment manager and accordingly, all such associated costs have to be borne by the manager and cannot be charged to the fund. Such expenses may include lease or rental charges, office maintenance, travel and outsourced support services, investment due diligence, transaction documentation costs pertaining to deal execution and such other costs. All three items appear in that list by name. The subtlety in option (c): it does not matter that the due diligence related to a deal the fund actually completed — the rule turns on the nature of the function, not the outcome. What the fund does bear is the one-time Set-up Cost for formation and initial sale of units, and operating expenses in relation to their engagement with external service providers, administrative costs, tax expenses, compliance costs — typically subject to caps investors insist on.
Where this is taught
Free preparation for NISM Series XIX-BRelated terms
- Private placement memorandumThe offer document of a Category III AIF, filed with SEBI through a merchant banker at least 30 days before a scheme launches — and the document SEBI comments on but never approves.
- First CloseThe date an AIF scheme declares it has raised enough commitments to proceed — the point from which tenure, management fees and set-up cost amortisation all start running.
- Management FeeThe fixed annual fee an AIF pays its investment manager for managing the fund — charged on committed capital in Category I and II funds and on gross NAV in Category III, regardless of performance.
- WrapperA supplement attached to a domestic fund's Private Placement Memorandum when it is distributed offshore, so the offering complies with private placement rules in the jurisdictions where it is marketed.
- Commitment PeriodThe window in a closed-ended fund during which the manager may call capital against commitments — and the period over which management fee is charged on committed rather than invested capital.