In this article, Colin Fernandes, currently pursuing Lawsikho Diploma in Entrepreneurship Administration and Business Laws discusses crowdfunding.

Are you aware that over 94% of new business fail during their first year of operation and lack of funding is one of the main reason. Crowdfunding is one of the new ways where business like startups can look for funding their operations and expansion.

What is Crowdfunding?

I would like to explain it through a simple example. During the festival of Lord Ganesha (Ganpati) in my hometown in Mumbai, the organizers of the festival (Ganpati Mandal) used to collect chanda (donation) for constructing the Ganpati pandal, organizing events for 9 days, etc. They used to visit each household in the vicinity for collecting the ‘chanda’ that is -donations in small and big amounts. The house owners contributed whatever amount they wished (some would simply refuse). In today’s world, this collection of chanda is called crowdfunding.

Today, crowdfunding is used for various purposes like funding a venture by raising money from a large number of people, especially via internet. The people who contribute are called investors, and they can contribute any amount of money depending on their capabilities. It targets individual donors.

Nonprofits organizations also use crowdfunding to collect donations. They often refer to crowdfunding as “online fundraising,” “social media fundraising” or “peer-to-peer fundraising.”

SEBI in its consultation paper defined “crowdfunding is a collection 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”.

What are the various forms of Crowdfunding?

Equity-based Crowdfunding

This form of raising fund is illegal in India (more will be explained). In this type of crowdfunding, investors (generally VC’s and angel investors) invest large funds to get a major share of equity in the startup. Normally equity-based crowdfunding is used typically used for the growth of the company.

Reward-based crowdfunding

There is no issue of securities in this form of fundraising. This is very common in the US. As the name suggests, investors will receive a reward (tangible goods) for their investments. For example, if a startup manufacturers phones, the investor will receive phones over a period of time in return for their investment. This form of funding is legal in India.

Donation-based crowdfunding

There is no issue of securities in this form of fundraising.  This type of funding follows a philanthropic approach where donors contribute for a social cause, project or any initiative without expectation of any reward in return. This form of funding is legal in India. Donors are generally provided with the background of the recipient, supporting evidence based on which he can decide to donate. He is always provided with an update.

Peer to Peer (debt) crowdfunding

In debt crowdfunding investors have the option to lend small amounts of money with a goal to earn fixed repayment interest during the term of the loan. Normally borrowers will seek unsecured loans from investors who want to earn higher Interest rates. This form of crowdfunding is regulated by the RBI.

List of Crowdfunding companies operating in India

Equity-based crowdfunding companies in India

1. Angelpaisa.com: commenced operations in July 2010 in collaboration with some of its counterparts in US and local investors by working on projects in the real estate sector and websites
2. Gocrowdera.com: Founded in California by 2 Indians and 1 American. It has global operations and has also established an Indian branch.

• Reward-based crowdfunding platforms

1. Wishberry.in: Founded in 2010 and operating in Mumbai, it is a donations-for-rewards crowdfunding platform and funds only creative projects like film production, design, photography, music, dance, art, etc.
2. Dreamwallets.com: HQ in Jaipur with branches in Mumbai and Pune, DreamWallets is an online reward-based collaboration platform. The people who invest are rewarded in non-monetary way.

• Donation based crowdfunding platforms

1. Milaap.org: HQ in Bengaluru, added donations on its portfolio in 2014. It supports people in need of funds for medical purposes, social projects.
2. Ketto.org: Mumbai-based Ketto supports allows people and NGOs to raise money for social, creative and personal causes

• Peer to Peer crowdfunding platforms:

1. Faircent.com: HQ in Gurgaon, this platform borrowers & lenders to discuss directly the terms of loans including interest rates. It is India’s first peer-to-peer (P2P) lending platform to receive a Certificate of Registration (CoR) as an NBFC-P2P from the Reserve Bank of India (RBI).
2. Rangde.org: Located Bangalore, it helps rural entrepreneurs with low-cost loans across the country.

Is crowdfunding legal in India?

• Reward-based, Donation-based crowdfunding is allowed in India as it does not involve the issue of securities.

• Equity-based crowdfunding

At present, equity crowdfunding is illegal in India.

SEBI had issued a consultation paper in 2014, regarding the regulation of equity-based crowdfunding in India. The concept of crowdfunding, its advantages, risks was analyzed and few guidelines as follows were issued:

• Accredited Investors are allowed to invest;
• Retail Investor contribution (Min  Rs. 20,000 & Max Rs. 60,000)
• Retail investors up to max 200
• QIBs (Qualified Institutional Buyer)must hold at least 5% of issued securities;
• Start-ups less than two years old only eligible
• Disclosure requirements & Registered crowdfunding platform to conduct regulatory checks of start-ups and investors

As a Surprise after issuing the consultation paper in a release in September 2016 SEBI issued a warning to Investors asking them to not participate in equity crowdfunding. In the release, SEBI declared that electronic platforms open to all investors registered with the platform amount to a contravention Securities Contract Act and the Companies Act.

(source https://www.moneylife.in/article/sebi-puts-brake-on-crowdfunding/48150.html)

Currently, SEBI is reportedly in the process of finalizing crowdfunding norms and is working with appropriate authorities.

Peer to Peer crowdfunding

Peer to Peer crowdfunding is legal in India. The RBI regulates all P2P lending platforms. In August 2017, RBI issued a notification and classified P2P lending platforms under the Non-Banking Finance Company (NBFC) category as NBFC-P2P.

(for notification click http://egazette.nic.in/WriteReadData/2017/179038.pdf)

On 4th October 2017, the RBI issued regulations for peer to peer (P2P) lending platforms. (source: https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11137&Mode=0)

Advantages versus disadvantages of raising finance through in crowdfunding:

Advantages

Disadvantages

fast way to raise finance if you are struggling to raise finance through bank loans or traditional funding You can get expert guidance from experienced investors Good platform to test the public’s reaction to your idea Projects which may not appeal to conventional investors can often get financed more easily Investors can often become most loyal customers through the financing process

Not an easier process as You will be dealing with investors with the different level of knowledge compared to traditional ways A lot of time will be involved in building up interest before the project launches  if you don’t achieve your funding target, any investment already made will be returned to the investors if IP (ideas, patents) are not properly guarded, someone can steal it as it is the marketplace type platform

What are the legal implications of equity crowdfunding (for investors)?

The biggest investor fraud case involves Subroto Roy owned Sahara group. Sahara real estate corporation raised over USD 3 billion from nearly 30 million investors through various means. It argued that the fundraising was not governed by SEBI regulations as it did not issue securities. As a result of the Sahara case, a provision was introduced in the Act which states that irrespective of whether a company intends to list its securities, if an offer to allot securities is made to more than fifty persons, it would be deemed to be an IPO. This will bring crowdfunding under the IPO regulatory umbrella.

(read more details at https://www.firstpost.com/india/how-saharas-subrata-roy-was-smoked-out-by-rbi-sebi-1413273.html)

Still, in its early stages, crowdfunding is set to grow very fast despite no legal frameworks to regulate it. SEBI and RBI are trying to regulate crowdfunding and its legal implication in India, but as the industry size being rather small currently it is a difficult task to draft a standard law or policy.

SEBI  is finalizing the regulatory framework for crowd-funding in consultation with the corporate affairs ministry. It may require all crowd-funding platforms to register with them, fulfill compliance requirements like these platforms will be asked to collect KYC documentation. They will also be required to send reports of all successful fund-raising exercises to the market regulator.

Conclusion

Crowdfunding is modern day term for “chanda”.  In today’s world, it is a market-based platform where investors with funds provide funds to a business in need of fund and all this happens in seconds. It can be distinguished into different types depending on the purpose the crowdfunding serves. There are many crowdfunding platforms operating in India some of which are regulated and some not. Sahara case was the biggest fraud in Indian history and it involved a crowdfunding setup. Due to the risks it possesses for investors and investees, SEBI and RBI are looking at ways to regulate crowdfunding companies as it is expected to grow rapidly.  

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 Students of Lawsikho courses regularly produce writing assignments and work on practical exercises as a part of their coursework and develop themselves in real-life practical skill.