Alternative Investment Funds (AIFs) are built on minimum investment thresholds: an investor typically commits at least ₹1 crore. At the same time, fund managers want their investment professionals to share in the upside they create, a practice common in private equity and venture capital. Issuing units to employees without asking them to invest capital appears to conflict with the minimum investment rule. SEBI resolves this through a specific carve-out for profit-sharing units.
This article explains the minimum investment rules, the carve-out for units issued to employees of the manager, the difference between profit-sharing units and employee investment, the limits of the flexibility, and practical safeguards for managers and trustees.
Key points at a glance
- The minimum investment in an AIF is generally ₹1 crore per investor under Regulation 10(c) of the SEBI (AIF) Regulations, 2012.
- Employees or directors of the AIF or its manager who invest may do so with a lower minimum of ₹25 lakh.
- Where units are issued to employees of the manager for profit sharing, without any capital contribution, the minimum investment requirement does not apply.
- The carve-out does not permit disguised or pooled employee investments below the minimum thresholds.
- Profit-sharing units must be disclosed in the PPM and must not dilute the economics of investors beyond what is disclosed.
What are the minimum investment rules for AIFs?
Regulation 10(c) of the SEBI (Alternative Investment Funds) Regulations, 2012 sets the minimum investment by an investor at ₹1 crore (for accredited investors, the minimum may differ as the regulations provide). For investors who are employees or directors of the AIF or of the manager, the minimum is ₹25 lakh. Large Value Funds require at least ₹25 crore per accredited investor.
These thresholds reflect the policy that AIFs are for investors who can bear the risk of complex, illiquid strategies.
What is the carve-out for profit-sharing units?
The SEBI Master Circular for AIFs (now dated 3 June 2026) clarifies that where units are issued to employees of the manager as part of profit sharing, and the units do not entail any contribution or investment from the employees, the minimum investment requirement under Regulation 10(c) does not apply.
The logic is simple. The minimum investment exists to protect investors who put capital at risk. An employee who receives profit-sharing units puts no capital at risk; the units are a share of the upside earned for managing the fund, much like carried interest.
Profit-sharing units vs employee investment
| Aspect | Profit-sharing units | Employee investment |
|---|---|---|
| Capital contribution by employee | None | Yes |
| Minimum investment | Not applicable | ₹25 lakh for employees or directors of the AIF or manager |
| Economic nature | Share of profits or upside, as disclosed in the distribution waterfall | Return on capital invested, pro-rata with other investors |
| Counts towards corpus | No | Yes |
| Disclosure | In the PPM, as part of the profit-sharing and carried interest terms | As any other investor |
What the carve-out does not permit
- Small employee investments: an employee who wants to invest ₹10 lakh cannot do so by calling the units profit-sharing units; any contribution brings the ₹25 lakh minimum into play.
- Pooling: employees cannot pool small amounts through a vehicle to meet the minimum indirectly.
- Disguised contributions: a notional contribution funded by the manager through a loan to the employee, or recovered through salary deductions, is still a contribution.
- Bypassing eligibility: profit-sharing units cannot be used to admit persons who are not genuine employees of the manager.
Practical point: The distribution waterfall in the PPM should show exactly how profit-sharing units participate, and when. Investors should be able to see that profit-sharing distributions come out of the manager's share of upside, as disclosed, and not out of investors' capital or preferred return.
Illustrative example
Consider a Category II AIF with a corpus of ₹300 crore, carried interest of 20% above an 8% hurdle, and a manager with a team of eight investment professionals.
- The manager decides that half of the carried interest will be shared with the team through a separate class of profit-sharing units.
- The units are issued to employees for no consideration, and the PPM discloses the class, its entitlement and the vesting conditions.
- Since there is no contribution, the ₹25 lakh employee minimum does not apply.
- Separately, two senior partners also invest ₹50 lakh each in the ordinary class. These are investments, subject to the ₹25 lakh minimum and ranking pro-rata with other investors.
- Investors' economics are unchanged: the profit-sharing units only redistribute the manager's share of upside.
Why this framework exists
- It supports long-term alignment of investment teams with fund performance.
- It preserves the minimum investment discipline for anyone who puts capital at risk.
- It ensures that employee incentives do not distort investor economics.
- It keeps governance clear by separating incentive units from investor units.
Governance checklist for managers
- Create a separate class of units for profit sharing, with rights defined in the PPM.
- Confirm in writing that no contribution, direct or indirect, is required from employees.
- Restrict eligibility to employees of the manager and document vesting and forfeiture on exit.
- Ensure distributions to the class follow the disclosed waterfall and do not reduce investors' entitlements.
- Keep employee investments, if any, in the ordinary class subject to the ₹25 lakh minimum.
- Include profit-sharing units in the scope of the annual PPM audit and in dematerialisation of units.
- Obtain tax advice on the treatment of profit-sharing units for employees and the fund.
Frequently Asked Questions on Units Issued to Employees of AIF Managers
Can employees of an AIF manager receive units without investing?
Yes. Units issued to employees of the manager purely for profit sharing, without any capital contribution, are permitted, and the minimum investment requirement does not apply to them.
What is the minimum investment for employees who invest in an AIF?
₹25 lakh for employees or directors of the AIF or its manager, against ₹1 crore for other investors.
Do profit-sharing units count towards the AIF's corpus?
No. Since no capital is contributed, such units do not add to the corpus.
Can the profit-sharing carve-out be used for small employee investments?
No. Any capital contribution, direct or indirect, is an investment and is subject to the minimum investment requirement.
Should profit-sharing units be disclosed to investors?
Yes. The class, its entitlements and its place in the distribution waterfall should be disclosed in the PPM so that investors can see the effect on their economics.
Conclusion
SEBI's framework allows AIF managers to reward their teams through profit-sharing units without forcing employees to invest at the ₹25 lakh or ₹1 crore thresholds. The condition is that the units carry no capital contribution and are clearly separated from investor units.
Clear documentation of the class, the waterfall and eligibility keeps the arrangement within its intended purpose: participation in upside, not a substitute for investor capital.
This article is intended for general information and knowledge sharing only and does not constitute professional advice or solicitation of any kind. Provisions are summarised as of September 2026. Readers should refer to the relevant provisions, regulations and judicial pronouncements for their specific facts.