1.0 Introduction
1.1 This consultation paper aims to provide a brief overview of the global scenario of crowdfunding including the various prevalent models under it, the associated benefits and risks, the regulatory approaches in different jurisdictions etc. The paper also covers the extant legal structure governing the fund raising for start ups and SMEs in India. The paper discusses legal and regulatory challenges in implementing the framework for Crowdfunding. This paper proposes framework for ushering in crowdfunding by giving access to capital market to provide an additional channel of early stage funding to Startups and SMEs and seeks to balance the same with investor protection. Through this consultation paper SEBI intends to invite comments and suggestions from industry and market participants regarding the different possible structures for crowdfunding within the existing legal framework and other associated issues.
1.2 The Consultation Paper has been put forward for discussion only and does not necessarily mean that a Crowdfunding Regulation would be introduced in the form as proposed in the consultation paper or in any other form.
2.0 What is Crowdfunding?
2.1 Crowdfunding is 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.
2.2 Crowd sourced funding is a means of raising money for a creative project (for instance, music, film, book publication), a benevolent or public-interest cause (for instance, a community based social or co-operative initiative) or a business venture, through small financial contributions from persons who may number in the hundreds or thousands. Those contributions are sought through an online crowd-funding platform, while the offer may also be promoted through social media.1
3.0 Types of Crowd-Funding
3.1 As per IOSCO Staff Working Paper – Crowd-funding: An Infant Industry Growing Fast, 2014 (‘IOSCO Paper’), Crowd-funding can be divided into four categories: donation crowdfunding, reward crowdfunding, peer-to-peer lending and equity crowdfunding.
3.2 Donation Crowdfunding
3.2.1 Donation crowdfunding denotes solicitation of funds for social, artistic, philanthropic
or other purpose, and not in exchange for anything of tangible value.
3.2.2 For example, In the US, Kickstarter, Indiegogo etc. are some of the platforms that support donation based crowdfunding.
3.3 Reward Crowdfunding
3.3.1 Reward crowdfunding 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.
3.3.2 Most of the websites which support donation crowdfunding, also enable reward crowdfunding, e.g. Kicktstarter, Rockethub etc.
3.4 Peer-to-Peer lending
3.4.1 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.
3.4.2 Some of the leading examples from the US are Lending Club, Prosper etc. and from UK are Zopa, Funding Circle etc.
3.4.3 A report by the Open Data Institute in July 2013 found that between October 2010 and May 2013 some 49,000 investors in the UK funded peer-to-peer loans worth more than £378m. 2
3.4.4 Some of the platforms charge a fee based on the loan origination and have an incentive to push investors into larger loans which may not suit an investor’s risk profile.
3.4.5 Though, Peer-to-peer lending did not appear to involve securities, loan/notes/contracts can be traded on a peer-to-peer platform or a secondary market. Thus, these loans may become securities, with the contract between the lender and the borrower being the security note. 3
3.4.6 In peer-to-peer lending, there is no investor protection by way of a compensation scheme to cover defaults in this market as there is with deposit guarantee schemes for bank deposits. Retail investors, who do not have the capacity to absorb defaults, may lose significant proportions of their investments, if there are any defaults.
3.4.7 As per IOSCO paper, in some Jurisdiction like Germany and Italy, peer-to-peer platforms are classified as banks (due to their credit intermediation function) and are therefore regulated as banks.
3.5 Equity Based Crowdfunding
3.5.1 In Equity Based Crowdfunding, in consideration of funds solicited from investors, Equity Shares of the Company are issued.
3.5.2 It refers to fund raising by a 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.
3.5.3 Traditionally, Start-ups are funded through private equity, angel investor or loan arrangements with a financial institution. Any offering of public equity takes place only after the product or business becomes commercially viable. However, in Equity based Crowdfunding solicitation is done at an earlier stage.
Some examples of equity crowdfunding platforms are Syndicate Room, Crowdcube and Seed rs.
3.5.4 In a few jurisdictions (like China), these platforms are restricted to offer this type of capital raising to sophisticated investors or to a limited number of individual investors. In China, an equity raising offer made to less than 200 individuals does not need to fulfil the public equity raising requirements.
4.0 Benefits of Crowdfunding
- Crowdfunding 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.
- Financial crisis (2008) resulted in failure of number of Banks and, consequently the Basel III Capital adequacy norms have been made applicable to Banks. As a result, Banks have become increasingly constrained in their ability to lend money to the ventures or start-ups which may have high risk element. Hence, there is a need for funding for SME through alternative sources.
- SMEs are able to raise funds at lower cost of capital without undergoing through rigorous procedures in this mode.
- Crowdfunding provides new investment avenue and provides a new product for portfolio diversification of Investors.
- It increases competition in a space traditionally dominated by a few providers (providing finance to Start-ups and SMEs).
- The operators of a crowdfunding platform may engage in vetting or due diligence of projects to be included on their website, to maintain the reputation of the website.
To Read More Download SEBI Consultation paper on Crowdfunding in India
