[The following guest post is contributed by Anantha Krishnan Iyer, a graduate of National Law University Lucknow (batch of 2008-2013) currently working with a leading law firm in Mumbai]
Pooling as a concept that has existed for a while now, as it is considered a useful solution to generate certain efficiencies. The advent of pooling of funds by multiple persons to fund a project, otherwise known as ‘crowdfunding’, is a concept which has been making waves around the world. With its inception in the early 2000s, crowdfunding has gained considerable momentum in both developed and emerging markets.
In 2014, the Securities and Exchange Board of India (SEBI) released a consultation paper on crowdfunding in India. While the securities market watchdog considered the types that an entrepreneur could avail, there certainly have been shortcomings in the points omitted to be addressed by SEBI in its paper. The types of crowdfunding can be broadly split up into Community and Financial-return based. While Community crowdfunding covers Donation-based and Reward-based crowdfunding, Financial-return pertains to Peer-to-Peer Lending and Equity-based crowdfunding. The concept provides a paradigm shift from traditional means of funding such as venture capital and angel investments. However, it does not provide a complete solution to providing funding to a startup company.
Dissecting SEBI’s Proposal
SEBI’s proposal recognizes crowdfunding as an innovative way to provide ‘modest amount of funding’ to young entrepreneurs in need of early stage capital to fuel their startup ventures. Proposing three routes namely Equity, Debt and Fund-based crowdfunding, SEBI has crystallized the framework proposed by specifying eligible investors, investment limits, conditions and recognition of crowdfunding platforms associated with such investments.
Eligible Investors: While Qualified Institutional Buyers (‘QIB’) and High Net Worth Individuals (‘HNI’) have been made eligible based on their net worth, the guidelines proposed for Eligible Retail Investors (‘ERI’) is quite hazy. Since the concept of crowdfunding is pivoted around pooling of funds from multiple small-time investors, it is quite likely that ERIs would form a majority of the investors. By proposing an ‘Appropriateness Test’ which may be conducted by the crowdfunding platform itself and placing dubious restrictions such as not investing more than 10% of their net worth in all crowdfunding investments per year or Rs.60,000 per investment, the framework for eligibility leaves a lot to be desired in terms of clarity.
Investment Limits: As a potential source of funding, SEBI has complied with international standards on its view on entities eligible for crowdfunding and has limited the funding which could be raised by such entities. With the United States allowing up to $1 million a year through crowdfunding (approx Rs. 6 crores), SEBI has raised the bar to allow Rs. 10 crores per annum for Indian entities. With entities that are only up to 48 months old being considered eligible for crowdfunding under the proposal, the SEBI has placed a time-cap on startups to realize their potential, which is a welcome move considering the burgeoning pace at which companies are established in India.
Disclosure by Issuers: With an increased risk forecast at stake, it would be pertinent to tighten the bolts on disclosure requirements placed on entities seeking crowdfunding. Following the United States model, which amongst international jurisdictions, places stringent disclosures on such entities, SEBI has listed a 13-point disclosure requirement. However, the inherent flaw with the proposal stems from the fact that SEBI draws parallels with public offers but fails to address the question of investors exceeding 200 in number in crowdfunded entities.
The Public Offer Conundrum
The Companies Act, 2013 (“Act”) specifies that any offer/invitation which is not in compliance with the provisions of Section 42 would be treated as a public offer. While the consultation paper released by SEBI deals at length with crowdfunding initiatives amounting to a private placement under Section 42 of the Act and the necessary procedure to be followed in such cases, it does not cover a scenario where the investors (apart from QIBs) exceed 200 in number.
The concerns have been partly addressed in case of Small and Medium Enterprises (‘SME’). However, SMEs are not currently required to make an initial public offer and are traded on the SME exchange, Institutional Trading Platform (“ITP”). Furthermore, one of the criteria for listing in the ITP is that such SMEs should not have their securities listed on any recognized stock exchange. Such a criterion put in perspective of the SEBI consultation paper effectively rules out a public offer opportunity for SMEs and Startups. It may also be noted that the paper rules out a secondary market to trade scrips of such companies displayed on a crowdfunding platform.
The Curious Case of P2P Lending
Peer-to-peer lending is another source of crowdfunded money, which can be traded through loans/promissory notes/contracts on a platform or a secondary market. Primarily dealing with unsecured loans carrying interest rates set by the platform which matches the borrowers with lenders, peer-to-peer lending has been pegged to be more than £400 million in the United Kingdom. While the SEBI paper recognized peer-to-peer lending to be a rapidly growing concept in recent years, with data backing the claim that such lending doubled year-on-year, it failed to take cognizance of the concept stating the such lending would not fall within the regulatory purview of SEBI. Citing the Reserve Bank of India to be the watchdog for such lending, the clarity over peer-to-peer lending was left hanging by SEBI. The RBI, to its credit, has recognized the concept of peer-to-peer lending in its Financial Stability Report dated June 26, 2014 and opined in the report that such a form of lending required regulatory attention. With the ball in the RBI’s court now, it would be quite interesting to see how the concept shapes up in India.
SEBI has gone all out in analyzing the various facets of crowdfunding in every other jurisdiction where the concept is prevalent. It has taken due note of the shortcomings and pitfalls associated with the concept as well. While it has countered some of these issues, there are still certain gaping holes left open and to be clarified. With other regulatory bodies such as the RBI are to be roped in to draft and finalize the set of regulations to govern crowdfunding in India, it does seem to be headed in the right direction. However, with a time crunch looming due to the breakneck pace at which startup ventures are opening shop, swift and immediate attention to roll out necessary regulations is the need of the hour.
- Anantha Krishnan Iyer