Crowdfunding is raising funds in small amounts from innumerable investors or by a group of individuals through a web-based platform or social networking site for a specific project, business venture or a social cause.
An investor giving Rs. 1000 for a project might not create huge importance, but 1000 people doing the same would generate serious money that could make a real difference to the project, creating jobs and may be rewarding investors in the long run.
Crowdfunding basically connects investors with small business start-ups, or projects through an online transaction portal that removes barriers to entry.
Crowdfunding is direct and simple. Businesses and investors put together a pitch for funding.
Investors can pick a project, make a bid and easily watch the numbers of investors grow from 1% to 99% until the target is hit and the money is raised for the project. But if crowd funders or investors don’t like the product or a particular project and don’t join in for the contribution, the raise won’t reach its requirement, but this would not take the funds back to the investors instead the raised funds will be provided to the business or the project owner and the business or the project owner have to limit itself from the raised amount and find some other source of funding, if required.
There are various types of crowdfunding some of them are as follows:
1) Donation based Crowd-funding: This is a way to source money from a large number of contributors to donate a small amount and not in exchange for any tangible value.
2) Reward based Crowd-funding: In this method, the contributor expects to receive some existing or future tangible reward (could be even a product or membership) in exchange of the money provided by him.
3) Peer to peer Crowd-funding: This method of crowdfunding removes the middle man and helps in coordination of the lender and the borrower directly amongst themselves.
4) Equity-based Crowd-funding: Here the investor invests his funds in a venture expecting to receive dividends, voting rights etc.
Crowd funding as an instrument is relatively new in India and is still under review by authorities like SEBI. A consultation paper circulated by SEBI dated 17th June 2014 invites observations/ views on the instrument and was studied as a part of the project. Some of the items covered in this discussion paper are mentioned below.
Expectation in return of Crowdfunding
1) Donation: – No expectation for return, but rewards can be received.
2) Lending to established business: – Interest on loan with the money back
3) Investing in a start-up: – Small stake which might turn into a huge stake someday.
Minimum amount to donate is small so diversifying is easy as vide range of projects can be funded.
Crowd-funding directly allows connecting people or prospective to businesses without any interim diaries.
5.1. INVESTORS IN CROWDFUNDING
Due to a high level of risk involved SEBI has proposed that only “accredited investors” to be allowed for crowdfunding activities. These accredited investors would include;
Institutional investors, Companies, HNI’s and even financially secured retail investors advised by investment advisors or portfolio managers are eligible as per the SEBI consultation paper.
Equity-based Crowdfunding and Debt based Crowdfunding are proposed to be allowed private placement offers through the internet such platforms to any number of QIBs and a maximum of 200 HNIs and ERIs combined.
Only ‘Accredited Investors’ are proposed to be allowed to invest via Crowdfunding platform. These Accredited Investors includes:
5.2. FUND RAISERS
As per the consultation paper dated filed with SEBI;
For start-ups and SMEs that either have limited access to capital or have exhausted other available sources of capital, crowdfunding acts as an alternative source of capital. So early stage startup or SME which is an unlisted public company incorporated in India can use this additional channel of crowdfunding platform to raise funds. There are certain criteria mentioned as per the consultation paper filed.
Apart from the above-mentioned clauses, only genuine entities can raise funds through this platform of crowdfunding to secure the investment of the investors.
However, a final structure in this regard is yet to be finalised.
Certain compulsory disclosures are required to be made by the issuer of the fund, which includes submitting a Private Placement Offer Letter via the crowdfunding operating platform. This offer would contain the following mandatory disclosures to be filed;
5.4. SETTING UP OF CROWDFUNDING PLATFORM
Fund raising activities by fraudulent entities may demotivate the new generation which beliefs in trusting the online source of financing or investing. Integrity, credit-worthiness, experience and solvency requirements thus become essential for the crowdfunding platform owners and the persons directly related to it. So, channelling of crowdfunding platform through SEBI recognised platform becomes a necessity.
Therefore SEBI has proposed entities falling in the given two classes can be allowed to set up a crowdfunding platform;
Any combination of both, or a joint venture of both these classes may also be taken into consideration for acting as a crowdfunding platform.
5.5. CROWDFUNDING WEBSITES IN INDIA
5.6. PROCESS OF FUND RAISING THROUGH CROWDFUNDING PLATFORM
5.7. SECONDARY MARKET
As many already existing jurisdictions like USA, UK, Canada are not providing the secondary market option to the investors of crowdfunding platform; as they mention; investing in such equity need to understand that investors will probably have to wait until an event occurs, such as the sale of the company, a management buy-out or a flotation, before getting a return.
So, SEBI in the consultation paper have followed the path of these countries and replicated their views by not providing provisions for secondary market. It also informs that it is difficult to provide a secondary market trading framework for the companies displayed on a crowdfunding platform, as then it would be treated as a Stock Exchange. Hence, companies displayed on Crowdfunding Platforms will not be treated as “Listed Companies” and there will be no secondary market liquidity in such scrips and investors should be made aware of such risks before investing in such companies.
5.8. CHALLENGES IN INDIA
5.9. STATUS OF CROWDFUNDING IN INDIA
SEBI has proposed a consulting paper which 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 also covering legal and regulatory challenges in implementing the framework for Crowdfunding. This paper informs the legal structure governing the fund raising for start-ups, SMEs, and various other entrepreneurial activities in India. This paper also talks about the framework for ushering in crowdfunding by giving access to capital market and seeks to balance the same with investor protection.
Following the success stories of e-commerce websites and small businesses based on innovative models in the start-up space, SEBI started engaging with a number of stakeholders to understand how it could help small businesses grow faster and access early-stage funding for SME’s and start-ups.
Then with a series of meetings with start-ups and merchant bankers, SEBI has set up an easier set of rules to allow local start-ups such as software product development firms and e-commerce ventures to raise capital through listing on stock exchanges.
If implemented, the proposals will improve access to funding for such firms and give them an alternative to offshore listings. India is home to nearly 3,000 start-ups.
In the discussion paper, SEBI proposed that start-ups list on an alternative capital raising platforms of Indian stock exchanges with easier compliance norms.
This platform would be part of the existing institutional trading platform, typically used for listing by small and medium enterprises
According to SEBI officials on new crowdfunding norms could be similar to the recently amended Jumpstart Our Business Startups (JOBS) Act in the US, which will even allow companies to publicly advertise and market their investment opportunities. And even similar to the Jumpstart Our Business Startups (JOBS) Act in the US and other legislations around the world, SEBI’s consultation paper also seeks to create exemptions for crowdfunding activities.
5.10. RISKS OF CROWDFUNDING IN INDIA
As investor money is involved in crowdfunding platform, it is mandatory to devise the structure in a legal frame work which will provide a regulatory protection to the investors participating in the crowdfunding. It is also imperative to educate the investors to operate on such a platform so that the intricacies of the process and system are made aware. Past experiences in many countries have reported few fraud cases as a part of crowdfunding. As the Indian markets are at the beginning of an economic revival where India is cited as one of the strongest among the emerging economies, this leaves space for several mala fide attempts by fraudulent investors to make an opportunity of this upswing.
Apart from this looking at the other way round, project or business failure or failure to execute challenges for which the funds were raised is the biggest concern.
The risk of illiquidity as there is not secondary market wherein the investors can exit the company whenever they want to.
5.11. ADVANTAGES OF CROWDFUNDING
There is no guarantee that investors will get rewarded or will get the dividend or something in return. While a majority of the business being start-ups, which may fail and the investor could land up with nothing in that particular project. If more shares are issued the investors return might get diluted.
While on the other hand, the investor might receive a share of the business or project. Dividends are very rare on the crowd-funding platform.
Debt Crowdfunding or peer-to-peer lending gives the option of regular returns in form of interest.
5.12. SUCCESS STORIES
An internet enabled away for business or projects for raising funds from multiple individuals is becoming an emerging trend in India. This Crowdfunding being has proved to be an emerging trend in India. Two of the successful entrepreneurs who have raised funds from the crowdfunding platform for their projects are as follows;
5.12.1. STUDENT DESK
A book exchange portal created and owned by entrepreneur Mr. Karan Pujara was successful in raising Rs.1.44 lakh from this crowdfunding platform. The portal students desk.in provides readers and facilitates them with the ready and free exchange of books and study material. This portal has also made tracking and exchanging of books easy with the help of location-based tracking of books facility available in the portal. This website also facilitates the exchange of magazines as a reader can’t subscribe to many magazines at a time.
5.12.2. SIGNS SPEAK
Signs Speak is an innovative and interpreting application that communicates with differently-abled individuals created by entrepreneur Kinjal Chaudhari. With the help of crowdfunding platform, Kinjal was successful in raising Rs.1.56 Lakh. This android based application is very helpful for interacting without knowing sign language. This mobile app has a combination of verbal and Indian sign language such that by choosing what to say, one can express him/herself without knowing another language. This makes communications possible for hearing and speaking impaired in their own sign language. Also, this app keeps together the verbal language that anyone else can understand without knowing the signs.
5.13. QUESTIONS FACED BY AN INDIVIDUAL INVESTOR
For an individual investor, it is of very important for him to know that his/her invested money gives proper return and growth out it. Following is a list of a questionnaire that a normal individual investor may face while using crowdfunding as a fund raising platform.
* CROWDFUNDING BASICALLY CONNECTS INVESTORS WITH SMALL BUSINESS START-UPS OR PROJECTS THROUGH AN ONLINE TRANSACTION PORTAL THAT REMOVES BARRIERS TO ENTRY. AS MAJORITY OF THE PRODUCTS FOR FUND RAISING AND SIMILAR ACTIVITIES ARE GUIDED BY SEBI MERCHANT BANKING REGULATIONS, CROWDFUNDING MAY BE CONSIDERED AN INSTRUMENT OF MERCHANT BANKING.