How Category-II AIFs Are Quietly Redefining MSME Financing in India’s High-Growth Economy
India’s MSME credit landscape is undergoing a pivotal shift driven by alternative investment funds that specialise in structured credit. Even as bank-led lending has improved in recent years, the system still leaves behind a massive Rs 30 lakh crore credit gap. Category-II Alternative Investment Funds have stepped in to fill this vacuum by offering flexible, cashflow-linked financing that supports MSMEs during critical growth phases. They operate in the space between traditional bank credit and equity finance, giving enterprises capital without dilution and investors a structured approach to risk.
What Category-II AIFs Actually Do
Category-II AIFs include private equity, private credit, structured debt and hybrid financing strategies. Their main advantage lies in the ability to design instruments that match a company’s real business cycles. Unlike funds focused on early-stage or developmental sectors, these funds have greater latitude to tailor repayment schedules, negotiate covenants and build structures aligned with cashflow strength. This balance of flexibility and discipline has made them increasingly relevant for MSMEs that need capital with predictable conditions.
Why Family Offices and UHNIs Prefer This Asset Class
The recent sharp rise in interest from family offices and UHNIs is largely driven by the search for stable, non-volatile returns. Public markets are unpredictable, and traditional fixed-income instruments offer limited yield. Category-II AIFs offer a middle path. Investors get contractual returns, strong downside protection, and reduced correlation with listed markets. Funds operating in this category typically build stringent monitoring systems, including escrow controls, reporting frameworks, and structured covenants, which instill confidence among sophisticated investors seeking clarity and control.
Where Banks Struggle to Support MSMEs
India’s banks have made progress in expanding MSME lending, but structural issues remain. Lending continues to rely heavily on collateral, asset-based assessments, and rigid underwriting. Many MSMEs operate in asset-light or fast-scaling sectors where traditional documentation cannot reflect true business potential. As a result, even fundamentally strong enterprises are unable to secure timely and adequate financing. Banks also do not offer complex solutions such as revenue-linked repayments, bridge capital or mezzanine debt, all of which growth-stage businesses often require.
How Structured Credit Closes the Gap
Structured credit platforms, particularly Category-II AIFs, excel in designing instruments based on real-time business performance rather than historical collateral. They use cashflow-based underwriting, monitor working capital cycles, and build repayment structures tailored to the company’s revenue pattern. This allows MSMEs to secure financing for capex, capacity expansion, technology upgrades or pre-IPO needs with far greater flexibility than banks can offer. This shift is significant because it aligns capital availability with operational realities rather than documentation constraints.
Veloce Fintech as a Market Example
Veloce Fintech’s launch of its second SEBI-registered Category-II AIF underscores the momentum in this space. The new Rs 300 crore fund has already secured over Rs 100 crore in commitments from family offices, UHNIs and business groups. It plans to deploy Rs 3 crore to Rs 15 crore per company across sectors such as manufacturing, healthcare, technology-enabled services, consumer industries, supply chain and real estate. Its first fund, fully deployed, is already generating scheduled repayments and structured distributions, reinforcing the strength of structured credit as a financing tool. The fund’s track record demonstrates that disciplined capital, when paired with predictable operating performance, can generate consistent outcomes for both investors and MSMEs.
Why Structured Credit Works Better for Growth-Stage Enterprises
For an MSME scaling rapidly, conventional loans often fall short because they do not consider the nuances of procurement cycles, revenue seasonality, or project-based cash generation. Structured credit solves this by linking repayments to business performance. A manufacturing company expanding capacity or a healthcare services firm adding diagnostic equipment can access financing that aligns with their ramp-up period. This is one of the reasons structured credit has gained traction across mid-market enterprises preparing for large-scale growth.
The Road Ahead for India’s MSME Financing Framework
India’s Rs 30 lakh crore MSME credit gap will require solutions that go beyond banking norms. Category-II AIFs bring a combination of flexibility, risk management and cashflow-linked structuring that fits the needs of modern enterprises. With private credit gaining depth and more institutional investors recognising its value, structured capital is set to become a core part of India’s MSME financing architecture. As funds like Veloce continue to demonstrate disciplined deployment and predictable returns, the alternative credit ecosystem is poised to play a defining role in the next decade of MSME growth.
The direction is unmistakable. MSME financing in India is advancing toward a model shaped not just by banks or equity investors but by a rising generation of structured credit funds that understand the operational realities of growing businesses.
