A Category II Alternative Investment Fund (AIF) is a SEBI-regulated private fund structure that pools capital from accredited investors — HNIs, family offices, and institutional investors — and deploys it as structured debt to mid-market Indian businesses. Category II AIFs are the primary vehicle through which India's private credit market operates. They provide the debt capital that banks and NBFCs cannot or will not provide — construction finance for mid-stage real estate projects, expansion capital for manufacturers at ticket sizes too large for NBFC relationships, acquisition financing for healthcare operators, and NCD subscriptions for companies that cannot access the institutional bond market.
For a business borrowing from a private credit fund, understanding how Category II AIFs work internally — how they raise capital, how they make lending decisions, and how they structure and monitor loans — is essential context for a productive borrower-lender relationship.
How a Category II AIF raises its capital
A private credit AIF is structured as a trust under Indian law. The fund manager sets up the trust, appoints a trustee, registers the fund with SEBI as a Category II AIF, and files a Private Placement Memorandum (PPM) with SEBI disclosing the fund's investment strategy, fee structure, target return, and risk factors.
The fund then raises capital privately from investors — there is no public offering. SEBI mandates a minimum investment of ₹1 crore per investor for Category II AIFs. Most private credit funds in India target HNIs and family offices at ₹1-5 crore per investor, and institutional investors (insurance companies, pension funds, other AIFs) at larger ticket sizes.
Fund tenures in the private credit space are typically 3-5 years — shorter than private equity funds because debt has defined maturities. Investors receive quarterly or semi-annual income distributions as borrowers service interest, with principal returned as loans mature. Net returns to investors in established private credit AIFs in India have historically ranged from 12-16% per annum depending on the credit quality of the portfolio and the fee structure.
How a private credit AIF evaluates a borrowing opportunity
When a business approaches a private credit AIF — directly or through a debt advisor — the fund's credit team begins a structured evaluation process.
Phase 1 — Preliminary screening (1-2 weeks): The credit team reviews the information memorandum or deal brief. The questions at this stage are: does this business fit our sector mandate? Is the ticket size within our deployment parameters? Does the proposed structure match how we lend? Is there a credible security package? If the preliminary screen passes, the fund issues a non-binding term sheet indicating its interest and the broad parameters at which it would consider the transaction.
Phase 2 — Credit due diligence (2-6 weeks): This is the most intensive phase. The fund's credit team examines: 3-5 years of audited financial statements, the current order book and receivables, the debt service coverage ratio under base and stress scenarios, the security package and its legal enforceability, the management team's track record, industry dynamics and competitive position, and legal due diligence on the company's title to the proposed security assets.
Private credit funds in India conduct more detailed pre-disbursement due diligence than most banks, because they do not have the same regulatory backstops and must rely on their own underwriting quality. This is not bureaucracy — it is the discipline that allows them to offer flexible structures that banks cannot.
Phase 3 — Investment committee approval: Every loan above a threshold — typically ₹5-10 crore — goes to the fund's investment committee for approval. The IC reviews the credit team's recommendation, challenges assumptions, and approves or declines the transaction. IC approval timelines range from 1 week (for well-prepared mandates in sectors the fund knows) to 3-4 weeks (for complex transactions or new sectors).
How the loan is structured and monitored
Private credit AIF loans are structured with covenants that go beyond what a bank term loan typically includes. Financial covenants are tested quarterly — DSCR, net debt to EBITDA, and minimum cash balance are the most common. A covenant breach — even without a payment default — gives the fund manager the right to request additional security, renegotiate terms, or declare an event of default. This monitoring intensity is why private credit is more expensive than bank debt — borrowers are paying for flexible structuring and are accepting tighter ongoing monitoring.
Security is formally created and legally perfected before any disbursement. First charge on land and building, assignment of receivables, personal guarantee from the promoter, and share pledge are the most common security components for mid-market transactions.
What makes a borrower attractive to a Category II AIF
The businesses that access private credit efficiently — without protracted negotiations or unfavourable terms — have four characteristics. Clean audited financials with no material qualifications. A clear and defensible security package that can be legally perfected before disbursement. Promoters who can demonstrate a track record of timely debt servicing on prior obligations. A specific and credible use of funds with a defined repayment mechanism.
Businesses that arrive with incomplete information, pending legal disputes over proposed security assets, or vague uses of funds create uncertainty that either delays the process significantly or results in the fund declining to proceed.
Eone Capital arranges private credit from Category II AIFs and NBFCs for established businesses with requirements of ₹30 crore and above.
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