Crowd Funding

The new found popularity of Crowd Funding or as per SEBI the way of solicitation of funds (small amount) from multiple investors through a web-based platform or social networking site for a specific project, business venture or social cause, is a result of current drive of startups and the after effect of the financial crisis. However, as of now there are no laws specifically regulating crowd funding, but a consultation paper was issued by SEBI discussing the probabilities of regulation the crowd funding but the same has been kept into backdrop of SEBI for a year now. Thus Crowd Funding cannot be called a legal method of fund raising but it’s also not illegal. The paper tries to analyze the background, concept and the current status of crowd funding in India with a small reference to various steps taken in its respect worldwide.

I. Introduction

Crowd Funding (hereafter referred to as “CF”) is a method used for funding a diversity of brand new ventures, allowing founders of cultural, for-profit or communal ventures to raise funding from general mass, often with the incentive of equity or future products. CF projects usually range greatly in both magnitude and goal, from small artistic projects to entrepreneurs seeking hundreds of thousands of dollars in seed capital as an alternative to traditional venture capital investment.1 These findings are majorly done on web basis, majorly through websites like Bitgiving, Wesberry etc.The concept of CF is not new and the evidence of its existence can be dated back to 19th century, where in it was first used for the building of the “Statue of Liberty”, and for a more local example would be that of the founding of Reliance Industries., where Mr. Ambani build his multimillion empire through CF.

II. Concept

As of now there are no laws which define the concept of CF. However, a Consultation Paper was issued by SEBI on June 2014 (hereinafter referred to as the “Paper”), which although not yet acted upon, but still gives the brief of the concept CF as of now and what it could be ones regularized. Thus the paper will define and discuss CF in terms of the Paper.

CF can be defined as solicitation of funds (small amount) from multiple investors through a web-based platform or social networking site for a specific project, business venture or social cause.

II.A Modes of CF

SEBI, in its paper while discussing the modes through which CF can be done, has taken into consideration the following four modes of CF as mentioned by IOSCO1

II.A.1 Donation

CFThis is more of a charity in nature, wherein socialization of funds in done for any social, philanthropic or any other reason, and specifically without anything tangible in exchange. These CF’s can be for a reason like Frendisco from Delhi trying to save a dog shelter, or a ‘Savve Sabha’ public appeal made during 69th Independence Day by a Pakistani NGO called Bluebells Community, to raise10 Lakhs as operating fees for a teenage girl.

II.A.2 Reward CF

This is a kind of CF where the investors receive present or future tangible rewards against any investment made. The rewards generally are the products being manufactured like Panono, a panoramic camera ball, which raised over 2 million $ in Germany this year.

II.A.3 Peer-to peer CF

Here borrowers take money from different peoples with a promise to return it with interest. This mode functions through online web portals where people in need approach the crowd for loans, with a promise to repay with the interest as determined by the lender.

II.A.4 Equity Based CF

This mode, although not legal ion India, involves investors taking equity shares against their investment. To regulate and prevent fiascos like Sahara the Paper proposes to limit the investment of these kinds of investment to 200 people (ERI and HNI) in a year, which is in line with the private placement provision in Companies Act 2013. However, this limit is not applicable to QIBs.

III. Eligible Entities to raise funds

The Paper defines Eligible Entity to be an

Indian incorporated ‘unlisted public company’

below 48 months of age, and

not related, promoted or sponsored to an industrial group having

annual turnover more than INR 25 Crores,

has an established business.

To ensure safety of investor, it is provided that the promoters, associates or directors of the Eligible Entity should not be suffering any disqualifications, from SEBI and Reserve Bank of India.

IV. Entities eligible to invest

The paper has allowed only two entities to make investment in CF, which are

‘Accredited Investors’ which includes

Qualified Institutional Buyers (QIB)

Indian companies having a net worth of INR 20 Crores and High Net-worth Individuals (HNI) having a net worth of INR 2 Crores, respectively

Eligible Retail Investor (ERI), who is an Indian citizen / NRI complying with the conditions mentioned in the Paper.

V. Eligible Platform for CF

To ensure that the web portals through which these fundings are being done are credible the Paper proposes three classes of entities eligible for offering the CF Platform.

Class I entities: recognized stock exchanges and SEBI registered depositories

Class II entities: Technology Business Incubators having specialized domain knowledge in the field of startup mentoring and funding, and

Class III entities: associations and networks of private equity or angel investors.

VI. Risk involved

The Institutional risk involved with institution like Venture Capital Fund and Private Equity Firms having higher risk tolerance, will be shifted to retail/small investors who have less risk tolerance.

The transactions being online and through advertisements, will be more prone to fraud.

Due to the “individual” nature of CF, there is a possibility that investors may not practice good diversification principles.

There may be no secondary market in which investors can sell their investments and exit and hence, there is a risk of illiquidity.

There is also possibility of Money laundering.

These platforms could expose other financial sectors to the risk of default, as occurred during the subprime mortgage crisis. If the rapid growth rate in peer-to-peer lending continues, these risks could become systemic.

There are Cross-border implications, if the funds are solicited through internet, as there are disparities in Contract Act or securities law application in different jurisdictions.

This will replace the present system of Bank loans and stringent disclosure and scrutiny process of public offerings of security, with more relaxed regulatory system.

Lack of transparency and documentation associated with CF.

VII. Conclusion

With the drive of startups and small companies, the traditional method of raising funds through private placements, primary markets, debt finance etc. are no more viable and easily accessible options. The regulatory and cost effect of IPO are not so much startup friendly, thus CF will be an option for new venture with noble business plan but no access to traditional fund raising modes.

Further as long as there are sufficient safeguards to prevent frauds under regulatory regime, raising equity capital through CF will be very helpful for budding of new ventures. However, this is also prone to fraud and most importantly they are vulnerable to regulatory arbitrage because of option for the entities to choose between multiple laws like (ICDR Regulation, CIS Regulation etc.) for less cost or compliances. Thus by keeping the above view in mind, CF through security issue, should be done in phases, so as to allow its better adaptation to Indian market.