Crowdfunding is described as “the
practice of funding a project or venture by raising many small amounts of money
from a large number of people, typically via the internet. It’s a new
go-to-strategy for budding startups. It is the practice of pooling in of
resources by numerous people, thus the term ‘crowd’, to fund prospective
projects. It is an alternative finance system where funds are raised through
mediums like internet-mediated registries, mail order subscriptions, and
benefit events and the like.
Crowdfunding is a popular concept
that emerged in the US and the UK. As of now, it has become an emerging way of
raising capital entailing the use of social media networks – Facebook, Twitter,
LinkedIn and some dedicated websites. The modern business environment considers
crowdfunding as a way of connecting investors with the modest business startups
and projects, using an online transaction portal that eliminates all the
possible barriers to entry.
Crowdfunding has become a serious
source of capital to kick-start new ventures and is by far the most disruptive
innovation of the 21st century. As an industry, crowdfunding has developed
steadily into a primary tool for entrepreneurs and creative people to assess
the potential for their ideas, engage with specific people who would be
interested in these ideas, and also attract the funding which is pivotal to the
success of any project. There are various types of crowdfunding, namely:
reward, donation, peer-to-peer, and equity-based. Out of which the Equity based
crowd funding is not legalized in India.
“Crowdfunding is a general
process of asking people for donations, which is then used as the capital by
startups. As crowdfunding involves pitching ideas directly to the internet
users, offering financial banking, entrepreneur and small business owners can
leverage it as an option to bypass venture capitalists and angel investors. It
also provides, a unique opportunity to validate the concept and scope of a
project in the targeted markets.”
Donation Crowdfunding – this
kind of crowdfunding denotes solicitation of funds for social, artistic,
philanthropic or other purpose, and not in exchange for anything of tangible
value.
Reward Crowdfunding – It
refers to solicitation of funds, wherein investors receive some existing or
future tangible reward (such as an existing or future consumer product or a
membership rewards scheme) as consideration.
Peer-to-Peer Crowdfunding - In
Peer-to-Peer lending, an online platform matches lenders/investors with
borrowers/issuers in order to provide unsecured loans and the interest rate is
set by the platform. Some Peer-to-Peer platforms arrange loans between
individuals, while other platforms pool funds which are then lent to small and
medium-sized businesses.
Equity Based Crowdfunding – In
this kind of crowdfunding, in consideration of funds solicited from investors,
Equity Shares of the Company are issued.
The article itself restricts to
following main objectives: first, to examine the regulation of equity based
crowdfunding in India; second, to ascertain if equity based crowdfunding
qualifies as a “private placement” or “public offer”; third, to determine if
the Securities and Exchange Board of India (“SEBI”) has the jurisdiction
to regulation equity based crowdfunding in India;
Equity Based Crowdfunding: The
Regulatory Conundrum
Equity based crowdfunding refers
to fund raising by business, particularly early – stage funding, through
offering equity interests in the business to investors online. Businesses
seeking to raise capital through this mode typically advertise online through a
crowdfunding platform website, which serves as an intermediary between
investors and the start-up companies.
The regulation of equity based
crowdfunding is a tricky question, since it comes with its own set of
advantages and risks. Its advantages include an unconventional funding
mechanism and an opportunity for the crowd to invest in securities. However, at
the same time, it comes with higher chances of failure and there is
information asymmetry. Regulation therefore requires deeper duties of the
advantages and disadvantages of such methods of funding.
Pros of Crowdfunding
ü
Provides a much needed new mode of financing for
start – ups and SME sector and increases flows of credit to SMEs and other
users in the real economy.
ü
It act as an alternative sources of raising
funds for SME.
ü
SMEs are able to raise funds at lower cost of
capital without undergoing through rigorous procedures in this mode.
ü
The method provides new investment avenue and
provides a new product for portfolio diversification of investors.
SEBI had also issued a consultation
paper in 2014, in which it asked for proposals and suggestions regarding
the regulation of equity based crowdfunding in India. In that paper, SEBI
analysed the concept of crowdfunding, its advantages, disadvantages and the
risks posed by it. It also leaned in favour of a restricted and highly
regulated mechanism for it, inter alia, limited investors to
accredited investors; it also imposed a requirement of 5% investment by
qualified-institutional buyers and restricted crowdfunding platforms to the
ones that qualify the high threshold requirement of Class I, Class II, Class
III entities.
Four main aspects of the
consultation paper stand out:
(i)
SEBI did not include retail investors;
(ii)
only unlisted public companies were stated to be
eligible for crowdfunding;
(iii)
advertisements were not allowed; and
(iv)
a cumbersome process is imposed on the issuing
company. However, the most important takeaway from the consultation paper was
SEBI’s observation that: “crowdfunding is intended to facilitate
capital raising through online medium by start-ups and SMEs and not for the
resale of securities. There is no requirement of listing for trading and no
listing obligation on the issuer.”
However, in a press
release issued on August 30, 2016, SEBI found that: “The electronic
platforms are allegedly facilitating investment in the form of private
placement with companies, as the offer is open to all the investors registered
with the platform amounting to a contravention of the provisions of Securities
Contract (Regulation) Act, 1956 (SCRA) and the Companies Act, 2013.” Thus,
it noted that compliance with SCRA, listing of issuing company and recognition
of the crowdfunding platform are mandatory. After enquiring with a few
angel investors about their mode of fundraising in August this year,
SEBI instructed them to issue a disclaimer that their activities are
not authorised by SEBI.
Thus, there is an absence of a
robust structure of law regulating equity of crowdfunding in India, and the
inconsistent approach taken by SEBI has led to confusion amongst investors and
fund-raisers alike.
Few Observations as to the
Status of Crowdfunding in India
Thus, there is a need of solid
crowd funding law and good regulation will enable the Indian Startups in a
great way which ensures that the probability of committing a fraud is near to
zero provided if some adequate steps are taken by SEBI to ensure protection.
This is because as Crowd Funding is done through the use of internet platform
it allows investors to directly connect with the Company. Thus, it needs more
transparency and democratize investment in startups. In the context of India,
transparency and trust is more essential as there are always numerous
complaints of small level businesses committing fraud with the people on
regular basis.
Conclusion
Crowdfunding has become a popular
method to raise money for early stage business and charitable organisations.
Globally, it is approximately a $34 billion industry. Although donation based
and reward based crowdfunding platforms are growing due to minimum regulatory
expectation the same is not the case with equity crowdfunding.
It has been observed that
are three modes of raising funds on certain online platforms for
start-ups. Under the first mode, the profile is visible to all; in the second
mode, the basic information about the company is
visible to all, but specific details of the company is given only permission;
and, under the last mode neither the basic nor detailed profile is visible on
any platform. Hence, although the last two modes may not be in violation of
private placement norms, the first may potentially constitute an illustration
of the types of crowdfunding platform referred to by SEBI in its caution note.
It is unlikely that the crowdfunding platforms that adhere to private placements
norms violate any law. Yet, SEBI’s observation that: “investors are hereby
cautioned that all dealings on such unauthorized electronic platforms would be
in contravention of the relevant securities laws,” raises
concerns about the validity of crowdfunding and has caused distress among
investors and fund-raisers alike.
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