[By Shruti Srivastava]
The author is a student of National Law University and Judicial Academy, Assam.
Introduction
Currently, India has more than 1,12,718 registered start-ups, making it the third largest start-up ecosystem globally after the USA and China. However, despite these burgeoning numbers, India has only 111 profitable unicorns. Among the many concerns that India’s startup ecosystem is facing, funding emerges as paramount. Though there are multiple avenues for startups to raise funds such as private equity, venture capital etc., a new route of crowdfunding has started making its place in the market.
Crowdfunding is simply the collection of small funds from multiple investors for some social cause, business venture or specific project, typically facilitated through web-based platforms or social networking sites. There are different types of crowdfunding, but not all of them need debates and discussions. Social lending or donation-based crowdfunding, for instance, is a type of crowdfunding in which donations are made without any expectation of investment. They carry minimal risk, but still, SEBI has issued Framework on Social Stock Exchange under which donation-based crowdfunding can be regulated. The second type of crowdfunding is peer-to-peer lending, wherein the platforms connect the lenders with the investors for loans of an unsecured nature. RBI came up with the Master Directions- Non-Banking Financial Company- Peer to Peer Lending Platform (Reserve Bank of India) Directions, 2017, which laid down the rules for peer-to-peer lending. Lastly, equity-based crowdfunding in which equity shares of a company are given to investors in exchange of funds, but it currently lacks legal recognition. This issue is discussed in detail later in the article.
This article commences by examining the contemporary discourse surrounding equity crowdfunding, elucidating its relevance and evolving dynamics. It subsequently conducts a comparative analysis between SEBI’s consultation paper on crowdfunding and the UK’s crowdfunding regulation. Lastly, the article offers a few suggestions and recommendations to enhance SEBI’s approach to crowdfunding.
Equity Crowdfunding in Contemporary Discourse
Recently, the Registrar of Companies (NCT of Delhi and Haryana) issued an order stating that two companies, Anbronica Technologies Limited and Septanove Technologies Private Limited, are liable for raising funds through the online equity crowdfunding platform, Tyke, as the fundraising was in violation of Section 42 of the Companies Act 2013. This order underscored the growing influence of crowdfunding platforms as pseudo- stock exchanges.
In 2017, SEBI raised concerns with LinkedIn, inquiring whether they provided a platform for start-ups to raise funds in contravention of the Companies Act 2013.
Furthermore, in the Sahara India Real Estate Corporation Limited & others v Securities and Exchange Board of India & another1, two companies of the Sahara groups, not listed on the stock exchange issued their securities to approximately 3 crore people in the name of private placement. This action violated the Companies Act of 1956 which allowed private companies to issue its securities to only 50 people. Subsequently, SEBI and later the Supreme Court of India held this act to be violative of the provisions of private placement. They clarified that if an issue is made to such a large number of people, it should be treated as a public issue.
It is important to note that at present, equity crowdfunding in India is not explicitly regulated and therefore this regulatory vacuum requires attention. However, in 2014, SEBI came up with a consultation paper acknowledging the usefulness of crowdfunding and proposed a viable regulatory framework. Furthermore, in 2016, SEBI issued a press release cautioning investors. The press release highlighted the increase in the number of digital platforms for raising funds, none of which are recognized or approved by securities market laws.
At this juncture, it is imperative to analyze whether the proposed framework is beneficial for India’s context. Additionally, a comparative analysis is important to understand what lessons India could learn from other jurisdictions.
SEBI’s Consultation Paper vis-a-vis UK’s Crowdfunding Regulation
The framework proposed by SEBI is similar to many functional models in other jurisdictions. However, the UK’s model is flexible, with its primary focus remaining proportional to the risk posed, making it more suitable for India.
The SEBI consultation paper proposes to allow only accredited investors to participate in equity crowdfunding, which includes Qualified Institutional Buyers (QIBs), Companies with a minimum net worth of Rs. 20 crore, Eligible Retail Investors (ERIs) and high-net-worth Individuals (HNIs). Though accredited creditors comprise ERIs, there are a series of restrictions imposed on them. For instance, they must be seeking investment advice from an investment advisor or have a minimum annual gross income of Rs. 10 Lacs. These restrictions create high entry-level barriers, keeping out many retail investors who might be interested in funding Indian startups.
While SEBI has proposed a minimum investment limit for all accredited investors, the UK’s model does not, however, have any restrictions on investments for investors who receive professional advice, are associated with venture capital or corporate finance businesses, or recognized as having a high net worth. Here, SEBI could benefit from the UK model by considering the removal of the minimum investment limit for QIBs and HNIs. They have multiple investment options available, and a minimum limit might act as a barrier to them. These accredited creditors possess a pool of resources, expertise, and experience. Therefore, even if they invest a relatively small percentage in startups, it can still be beneficial. They are likely to invest in startups with a higher probability of success; aiding small retail investors in their decision-making and protecting them from investing in startups with poor outlooks.
Secondly, disclosure requirements are crucial for crowdfunding, but they must differ from IPO disclosures. In the UK, crowdfunding regulations emphasize providing investors with fair, clear, and non-misleading information to support their investment decisions. However, while the UK regulation talks about disclosure requirements, it does not specify compulsory disclosures. Not specifying the disclosure requirements can leave a grey area, and because of this, SEBI has suggested a list of disclosure requirements that have to be made by a company.
Lastly in the UK, if a project fails to raise the minimum amount of funding, then either the project can be cancelled and the investors’ money returned, or the project may be given an extension, which is negotiated between the parties and decided upon with varying timelines. However, SEBI fails to specify any such steps that could be taken if a project fails to receive funding. Furthermore, SEBI should not impose any restrictions on the fees charged by platforms to accredited creditors and issuers. These platforms should be allowed to make their own commercial decision, considering market forces. The UK has also adopted a flexible approach; typically, platforms in the UK charge a success fee in addition to the listing fee, while others take a percentage of the profit made.
Enhancing SEBI’s Crowdfunding Approach: Key Recommendations
Crowdfunding involves collecting funds from multiple investors. While there may be multiple accredited investors interested in a crowdfunding project, these individuals possess skills, experiences and well-established networks. They have multiple investment options available, making it challenging to draw their attention towards crowdfunding. To address this problem, certain restrictions such as availing services of a portfolio manager or receiving of investment advice and having the resources to fight against the losses on their investment, could be eliminated. This would broaden the scope of accredited investors, thereby increasing the number of retail investors that fall under the current definition.
In its consultation paper, SEBI has divided crowdfunding platforms into three classes of entities. The capital requirements for all these classes are on the higher end, which may deter many potential crowdfunding platforms from the market. These capital requirements could be relaxed to a certain extent. Additionally, for the entities not falling under these classes, SEBI can introduce a macroprudential screening layer in order to avoid money laundering and fraud concerns.
Furthermore, future projections of the company should also be made on these platforms owing to a lack of business history or financial track record. However, there must be a concrete mechanism to check whether these projections are trustworthy or not. A body could be established whose role would be to study the market in which the startup is going to enter, analyze its past history, and then come up with its projections. The analysis could then be published on the website in order to ensure that issuers do not mislead the investors. However, utmost care must be taken when finalizing the list of disclosures and establishing a governing body, as these actions may increase compliance costs.
Lastly, an important aspect of cross-border crowdfunding is absent in SEBI’s regulatory framework. It has not addressed foreign investors funding Indian issuers, nor has it mentioned Indian investors participating in crowdfunding activities in other jurisdictions. Given the reach of web-based platforms and social media sites, it is crucial for SEBI to address this gap.
Conclusion
In contrast to India, the equity crowdfunding laws are well established in countries like the US, UK, Italy and Singapore. From 2023 to 2030, the size of the global crowdfunding industry is projected to increase at a compound annual growth rate of 16.7%, reaching USD 5.53 billion by 2030. The growth will also be witnessed in India, pressing the need to remove the overall ambiguity in SEBI’s framework; as such ambiguities might deter investors and affect the growing startup ecosystem in India.
It has been nearly a decade since SEBI released its consultation paper. The framework presented by SEBI has a few loopholes and now it has become crucial for SEBI to go through the framework it had presented earlier, fill in the loopholes, address the grey areas and come up with a proper compliance framework and regulatory procedures for fundraiser, fundraising agency and investors.