To rein in the crowd in Crowdfunding

The requirement for funds for small companies in India cannot be underscored more than the buzz that it has already received. Therefore, it is indeed welcoming to note that the Securities and Exchange Board of India (SEBI), in June, released a consultation paper that provides the regulatory overview for crowdfunding in India.

A number of crowdfunding platforms have already sprung up in India in at least the last 2 years. These platforms typically fall in the social lending or reward crowdfunding category. Currently, such platforms are established as private limited companies, and therefore fall under the purview of the Companies Act alone, despite the presence of retail investors. The discussion paper therefore seeks to address regulatory concerns for such platforms.

Background: Global Precedents

In the US, the concept derives its regulatory framework through the JOBS Act (Jumpstart Our Business Startups Act, 2012) under which there is a cap on the amount that can be raised to the tune of $1 million for a 12 month period. In New Zealand, the concept has been covered under the Financial Markets Conduct Act, 2013 where a company can raise a maximum of $2 million from 20 investors in a year.

SEBI’s consultation paper has provided a cross-sectional analysis of the regulatory framework across a few geographies.

Definitions:

Crowdfunding and Crowd Sourced funding are two terms that have been defined. According to the paper, crowdfunding refers to the 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.When SEBI provides a draft rules in the near future, it will hopefully define what constitutes this small amount, and what the accepted social networking sites would be.

The paper also provides the qualification criteria for retail investors in addition to providing 3 classes under which the crowdfunding platforms may be registered.

Crowdfunding platforms

As per the paper, it shall be mandatory for the platforms to be registered with SEBI under three categories strictly. Broadly, the entities that fall under this include recognized stock exchanges, SEBI registered depositories, Government-backed technology business incubators, (or a JV between such entities), or an association or network of private equity or angel investors. The paper also outlines the responsibilities of such platforms.

Going by the current scenario, there could be a possibility of existing platforms to be invalid if these requirements become law.

Entities that can receive crowdfunding

The paper necessitates that the company interested in crowdfunding be not more than 4 years old and necessarily unlisted. Further it cannot raise over Rs 10 crore in a 12 month period via equity. Companies may also raise an equivalent amount by issuing debentures or debt securities. Real estate companies and activities not permitted under the industrial policy have been excluded from this.

The paper also recommends a new classification of Alternate Investment Funds (AIFs): Category I AIF- Crowd Funds for which the investment amount maybe relaxed.

Interestingly, according to the paper, a company may receive foreign funding as well. In this case, would not the RBI also share its view on the regulatory aspects covering crowdfunding? Moreover, will the entities contemplated in the paper to receive funding include LLP’s, sole proprietors, and partnership firms?

Investors

The paper prescribes the class of investors who qualify as participants in crowdfunding. This includes qualified institutional buyers, companies with a minimum net worth of Rs. 10 crore, HNIs with a minimum net worth of Rs. 2 crore and retail investors. The requisite qualifications attached to retail investors are interesting: after all, there are no such requirements even to invest in companies trading say in the Bombay Stock Exchange. Additionally, there are caps to investment for such type of investors. One wonders the rationale behind this. Even if the objective is to address retail risk, isn’t crowdfunding on a lesser magnitude compared to other fund raising platforms? Additionally, why do companies need to have a minimum net worth?

The concept of crowdfunding, a relatively new concept even in the western countries, seeks to bridge the lacuna in funding options that exists between bootstrapping and angel investments. Lack of regulations also gives room to questions regarding a possible routing of unaccounted funds to such business ventures. Thus it will be interesting to see the kind of comments that SEBI has received for the paper and the regulations that will finally be in place.