Introduction
By raising capital from a large number of investors, a project or a venture can raise funds through crowdfunding. Online charity events and social networks are usually used for crowdfunding. Fundraising through crowdsourcing is currently used widely for artistic projects, start-up companies, medical expenses, travel, and community-based social entrepreneurship projects. ArtistShare was the first company to implement a crowdfunding business model. More crowdfunding sites like Kiva, GoFundMe, MicroVentures, YouCaring, etc.[1] started appearing with the passage of time and as the model matured. In addition, crowdfunding companies are hoping that the budget will include good policy changes to promote their growth. This industry needs a proper regulatory framework and compliance framework in order to fully realize its potential. However, it is still limited by the lack of clarity in its regulatory framework and compliance framework. Many people and groups were assisted by crowdfunding during Covid. The blog will analyse the present scenario of crowdfunding in India by overviewing the latest developments by SEBI and effective solutions for the model to make a better place for crowdfunds in the market.
Page Contents
What are the existing Regulations for Crowdfunding?
Regulatory framework measures to be a governing procedure for the security-based crowdfunding methods have been proposed by the Securities and Exchange Board of India (SEBI) in its Consultation Paper on Crowdfunding in India. Funding for a crowdfunding project can only be made available to accredited investors. According to SEBI, to qualify as an ‘Accredited Investor’, a company must have a minimum net worth of Rs 20 crore, a high net worth individual must have a minimum net worth of Rs 2 crore, and an eligible retail investor must have a minimum net worth of Rs 5,000.[2] A set of restrictions has also been proposed by SEBI on the kinds of companies that can raise capital through security-based crowdfunding. It is been advised that during a 12-month period, the maximum amount of capital raised by a company should not exceed Rs 10 Crore, also, an organization that has a turnover of more than Rs 25 Crore shouldn’t be promoted, sponsored, or affiliated with any industrial group. Additionally, In accordance with the industrial policy of the Government of India, it should not engage in real estate business and other activities not permitted.
Rebooting the model in pandemic
In the wake of the Covid-19 pandemic, traditional financing sources is shrinking, limiting the ability of small businesses and start-ups to raise money. Under normal circumstances, such ventures are often unable to raise money through traditional methods (such as private and public equity offerings and debt financings) due to onerous regulatory and screening requirements. This situation will be exacerbated by the pandemic because of the government lockdowns, small shops and ventures will be shut and the businessmen will have no choice of earning a livelihood. The investors will be unable to invest in the market which will cause low funding in the sector, therefore, the downfall of the overall economy.
As a result, crowd-funding could be an effective means to increase their access to finance, since it runs on a digital platform and has a greater public reach. Although crowd-funding for Covid-19 related issues has raised substantial amounts of funds through donations, businesses cannot raise funds through equity-based crowdfunding. SEBI had made a proposal for a regulatory framework to allow crowdfunding in India in 2014 but ultimately decided against the plan.[3] In the paper, the SEBI permits access to the capital market, it introduces new forms of crowdfunding for start-ups and small businesses while simultaneously assuring investor protection by providing access to the capital market as an additional early-stage funding source. However, it has not paid attention to the market in a situation like a pandemic, which will drastically affect the small ventures in the market. Changing circumstances following the Covid-19 pandemic should encourage SEBI to rethink its position. The arena of online shares and marketing have been established in the wake of the pandemic, and still, it is growing rapidly to help businessman to earn their livelihood.
Indian crowdfunding is expanding due to the growing number of fintech businesses and entrepreneurs. Yet the act does not provide any guidance on equity-based crowdfunding or online-based crowdfunding. It is time to look at the probable scenario for crowdfunds in India.
Making it big with crowdfunds!
Despite the widespread association between crowdfunding and raising capital for new businesses, many small businesses are turning to crowdfund as a way to do business again. It would be better to ask, “What will equity crowdfunding look like in the future?” We’ve already seen remarkable progress in just a short period, such as with the first equity crowdfunding unicorn, where multiple companies worth billions of dollars were raised via equity crowdfunding. Considering that new companies have no previous track record, crowdfunding should be regulated, but it must also be avoided over-regulating them or overburdening budding entrepreneurs with overly restrictive rules. By focusing on caution, SEBI has taken the crowd out of crowdfunding in its Consultation Paper.[4] Despite the seriousness of the regulations, the ones proposed by SEBI concerning the number of accredited investors, the bracket of accredited investors, and the cap on investments, may need to be relaxed or altered in order to maintain the process as viable and beneficial as possible and not obliterated in the process of regulation itself.
Regulation and legislation are challenged by any technological advancement. Crowdfunding is one area where SEBI has adopted a very cautious approach and has laid down guidelines that guarantee investor protection. The report takes note of the downsides of crowdfunding, as well as the advantages. Despite these challenges, there are still several aspects of crowdfunding that need clarifying, and aspects that need regulating, which play a vital role in the process. These include arenas such as cross-border transactions and secondary markets. The Indian economy will be taken by storm if SEBI takes these suggestions seriously and regulates the avenue of crowdfunding, giving SMEs a strong boost and making India a hub of investment and innovation. Despite SEBI’s Consultation Paper being available for two years, no guidelines or rules have been developed based on the responses it received. SEBI should regulate crowdfunding as it is a vital source of raising capital in the economy. Several innovative businesses and ideas might stagnate in this situation, which might seriously harm the economy over time.
Dealing with the Framework
A new framework should be in place for equity-based crowdfunds of small businesses and start-ups, given the role an online securities market can play in supporting the recovery and growth of small businesses post-Covid. There have already been specific rules governing equity crowdfunds in the United States, Australia, Italy and Malaysia. Regulations in these countries focus on investors, who will be protected by separating their investments from the platform’s finances. Thus, if anything happened to the platform, there would be no harm done to the investments. Furthermore, the platforms should have a contingency plan in place or a third party on hand to ensure seamless operations. Their regulations take a robust view on disclosures. Marketers should not mislead consumers and all risks should be adequately highlighted on product packaging. As a result of the regulations, platforms will be able to manage their risks properly and not promise some ludicrous return. A law of this nature would allow businesses to (a) raise equity from the public; (b) offer securities through online ‘crowd-funding’ platforms without demeaning investor rights; and (c) carve out exemptions and exemptions from the securities laws in general without undermining the rights of investors.[5]
In light of the potentially high risks associated with crowd-funded enterprises, the legal framework needs to establish clear eligibility rules and disclosure requirements. A platform offering such services might be required to conduct ‘online appropriateness tests’ to determine whether investors are risk-aware. For investors to avoid suffering substantial losses, the law should limit the amount of money they can invest at any one time. In addition to leveraging social media platforms, crowdfunding platforms can facilitate constant communication between investors and issuers, along with appropriate disclosure requirements. Drafting a framework law enables equity-based crowdfunding for the general public. The Companies Act 2013 should be amended to include appropriate exclusions, since it prevents private companies from offering securities to more than 200 individuals in a financial year, and ensures a public offering for companies with more than 200 offerees. It is recommended that appropriate exclusions be added to the Securities Contracts Regulation Act 1956 and the Securities and Exchange Board of India Act 1992 regarding public offerings of securities and to compliance requirements for the recognition of crowd-funding platforms.
Conclusion
Crowdfunding has high levels of dynamic activity. In addition to promoting and representing new innovations, investors invest in the company to validate market demands. Crowdfunding regulations exist in several countries that have fewer citizens than India, which have enabled stakeholders to leverage the power of the crowd for their ideas, dreams and fuel business growth. A new era fuelled by the crowd that supports those without access to a primary mode of financing has opened up with crowdfunding. This crowdfunding-based economy will function more smoothly if regulation and legal accountability are clarified.
In the post-Covid world, crowdfunding will get a bigger foothold in India. As a matter of fact, this positive trend is already evident today with numerous philanthropic campaigns being conducted. In light of its positive influence on our society, we are faced with a dilemma about what remedy to adopt. In essence, a good compliance law and regulatory process are necessary in order to make the Indian market a success. The investors and the businessmen will be able to know the risk factor through online tests and where to invest for better profitability. Setting limits for minimum loss can be implemented by the control board and crowdfunding platforms for constant conclaves can be used by the issuers and investors. There should be a focus on public offer of securities and concerning compliances for recognition of the crowd-funding platform by SEBI for better facilitation of crowdfunds in India.
This article is written by Mr Aayush Akar & Ms Isha Bharti.
[1] ‘Crowdfunding – Corporate/Commercial Law – India’ <https://www.mondaq.com/india/securities/1128896/crowdfunding> accessed 11 April 2022.
[2] ‘Sebi: Sebi Comes out with Modalities for Accredited Investors – The Economic Times’ <https://economictimes.indiatimes.com/markets/stocks/news/sebi-comes-out-with-modalities-for-accredited-investors/articleshow/85667933.cms?from=mdr> accessed 11 April 2022.
[3] Pallavi Chakravorty, ‘How Crowdfunding Is Transforming Lives’ The Economic Times (23 April 2021) <https://economictimes.indiatimes.com/small-biz/sme-sector/how-crowdfunding-is-transforming-lives/articleshow/82213708.cms> accessed 11 April 2022.
[4] ‘Thrive with the Crowd – Times of India’ <https://timesofindia.indiatimes.com/thrive-with-the-crowd/articleshow/75288630.cms> accessed 11 April 2022.
[5] ‘Allowing Equity-Based Crowd-Funding’ (Vidhi Centre for Legal Policy, 21 August 2020) <https://vidhilegalpolicy.in/blog/allowing-equity-based-crowd-funding/> accessed 11 April 2022.
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