Crowdfunding is solicitation of small amounts funds from multiple investors through a web-based platform or social networking site for a specific project, business venture or social cause.1 This process is being practiced all over the world as an alternative to traditional funds raising. It is an alternate source of finance which facilitates interaction of entrepreneurs and prospective investors on an online platform where the former 'pitch' their business ideas and plans with an objective of attracting investments from the latter. Crowdfunding is beneficial as it widens the reach of entrepreneurs beyond the conventional circle of friends, relatives and venture capitalists.
It can be broadly divided into four categories: donation crowdfunding, reward crowdfunding, peer-to-peer lending and equity crowdfunding.
1. Donation Crowdfunding: It involves raising funds for social, artistic, philanthropic or other purposes. This model can be used for raising funds for causes ranging from disaster relief to education sponsorships, charity causes, and payment of medical bills. There are no financial incentives for donors. Donations are made purely as an act of philanthropy.
2. Reward Crowdfunding: This method is modification of the Donation model. Donors are given an incentive of some existing or future tangible reward for making contributions. Reward may be in the form of a product or a service, for example, pre-launch edition of a newly developed video game or complimentary meal coupons. Reward Crowdfunding is appropriate for businesses where a creative idea or innovation is involved.
3. Peer-to-Peer Lending or Debt Crowdfunding: Peer-to-Peer Lending (P2P lending) is a form of crowdfunding used to raise loans which are re-paid along with interest. It can be defined as the use of an online platform that matches lenders with borrowers in order to provide unsecured loans. The borrower can either be an individual or a legal person requiring a loan. The interest rate may be set by the platform or by mutual agreement between the borrower and the lender. Fees are paid to the platform by both the lender as well as the borrower.2
4. Equity Crowdfunding: It refers to fund raising by a business, particularly early-stage funding, through offering equity interests in the business to investors online. Businesses seeking to raise capital through this mode typically advertise online through a crowdfunding platform website, which serves as an intermediary between investors and the start-up companies.
A distinct form of Security based Crowdfunding has been devised by the Securities and Exchange Board of India (SEBI) in the Consultation Paper on Crowdfunding in India (SEBI Consultation Paper), viz. Fund based Crowdfunding (FbC). It has been proposed that under the FbC model, the funds of the accredited investors [Qualified Institutional Buyers (QIBs), Companies, High Net worth Individuals (HNIs), Eligible Retail Investors (ERIs) which fulfil the prescribed qualifications] registered with a recognized platform will be collected online through the platform and pooled under the Alternative Investment Fund ("AIF") to invest in shares or debt securities in crowdfunded ventures which are displayed on a recognized crowdfunding platform.
The SEBI Consultation Paper furnishes proposals for a regulatory framework governing procedure of Security based Crowdfunding methods for Start-ups and Small and Medium Enterprises (SMEs).
It provides that only an 'Accredited Investor' can invest money in a crowdfunding project, where qualifications of an 'Accredited Investor' have been prescribed thereof as under:
- Companies incorporated under the Companies Act, with a minimum net worth of Rs.20 crore.
- HNIs with a minimum net worth of Rs.2 crore.
- ERIs who fulfil the prescribed criteria.
The SEBI Consultation Paper proposes to place restrictions on the kind of companies that can raise funds through Security based crowdfunding, some of which are as follows:
- The company intending to raise capital NOT exceeding Rs. 10 Crore in a period of 12 months.
- A company which is not promoted, sponsored or related to an industrial group which has a turnover in excess of Rs. 25 Crores.
- A company which is not listed on any exchange.
- A company which is not more than 4 years old.
- A company which is not engaged in real estate and activities which are not permitted under industrial policy of Government of India.
Also, it is proposed that a crowdfunding platform has to be necessarily recognized by the SEBI, and that it should fulfil the given integrity, experience and solvency requirements.3 Peer-to-Peer Lending is regulated by the Non-Banking Financial Company– Peer-to-Peer Lending Platform (Reserve Bank) Directions, 2017 (The Directions).
The Directions define a "Non-banking financial company - Peer to Peer Lending Platform"4 (NBFC-P2P) as a non-banking institution which carries on the business of a Peer-to-Peer Lending Platform. Peer-to- Peer Lending Platform5 has been defined as an intermediary providing the services of loan facilitation via online medium or otherwise, to the participants6 (a person who has entered into an arrangement with an NBFC-P2P to lend on it or to avail of loan facilitation services provided by it). Non-banking institutions other than companies have been prohibited from undertaking the business of Peer-to-Peer Lending platform.7 The Directions provide the scope of activities, prudential norms (the aggregate loans taken by a borrower at any point of time, across all P2Ps, is subject to a cap of Rs.10,00,000/-), operational guidelines, inter alia other regulations.
CROWDFUNDING - TREATMENT IN FOREIGN JURISDICTIONS
In USA, Jumpstart Our Business Start-ups Act (JOBS) Act, 2012, is the regulatory law on Crowdfunding. Title II of the JOBS Act regulates equity offers made to accredited investors. Title III deals with equity offers to general public or CSEF (Crowd Sourced Equity Funding). These provisions allow start-ups and other small investors to raise modest amounts of capital through an online platform. This Act provides thresholds for a transaction to qualify as a crowdfunding transaction, and puts limits on the amounts that can be raised and investments made through the online platform.
Financial Conduct Authority (FCA) is the regulatory authority that governs crowdfunding in Britain. Crowdfunding is regulated by broadly dividing it into four types: Investment based, Loan based, Donation based and Pre-payment/Reward based. Investment based and Loan based Crowdfunding are regulated activities under the Financial Services and Markets Act, 2000. Donation based and Pre-payment/reward based crowdfunding activities are regulated under The Payment Services Regulations, 2017.8
One of the first nations to enact a law on Equity Crowdfunding was Italy. Regulation on "the collection of risk capital via on-line portals"9 (adopted by CONSOB10 with Resolution no. 18592 of 26 June 2013, last amended by Resolution no. 20264 of 17 January 2018) is the relevant law governing Crowdfunding. The thrust of the law is to regulate the process of inflow of capital to "innovative start-ups" and "innovative SMEs".
Portals are required to be registered with CONSOB11 and they are entrusted with the duty of shareholder protection.
In Australia, The Corporations Amendment (Crowd-sourced Funding) Act, 2017, amends the Corporations Act 2001 (Corporations Act), and makes minor amendments to the Australian Securities and Investments Commission Act 2001 to govern provisions relating to crowdfunding in Australia. The Crowd-sourced Funding (CSF) Regime seeks to reduce the regulatory requirements for public fundraising while maintaining appropriate investor protection measures. It has been made obligatory for a CSF service provider to hold an Australian Financial Services (AFS) licence.12
Crowdfunding is a type of financial market service covered by the Financial Markets Conduct Act, 2013 (FMC Act).13 The FMC Act regulates equity based crowdfunding. Companies are allowed under the FMC Act to raise up to $2 million in any 12-month period, without having to issue an investment statement or prospectus (or a product disclosure statement from 1 December 2014). The prevalent Crowdfunding rules have made it easier and quicker for small companies to raise money. There are relaxations in filing and other compliances for companies seeking to raise funds through a licensed crowdfunding service provider.14
SEBI has sought to achieve an "enabling framework" through the proposals suggested in its consultation paper. The cost of raising funds for start-ups and SMEs has been reduced by cutting down the documentation and filing requirements. Thereby the process of crowdfunding is made easier in comparison to the regular equity route. However, the substitution of the existing framework may have the consequence of exposing retail investors to unscrupulous players.
The current status is that online crowdfunding platforms are neither authorized by SEBI nor recognized under any law governing the securities market. All crowdfunding transactions made on electronic platforms are in contravention of securities laws. Hence, the Caution notice15 puts the crowdfunding regime in a grey area in the Indian regulation framework.
1 Consultation Paper on Crowdfunding in India, Securities and Exchange Board of India (dated June 2014) available at http://www.sebi.gov.in/cms/sebi_data/attachdocs/1403005615257.pdf .
2 Consultation Paper on Peer to Peer Lending in India, Reserve Bank of India (dated April 2016), available at https://rbidocs.rbi.org.in/rdocs/content/pdfs/cperr280416.pdf .
3 The SEBI Consultation Paper, supra.
4 Non-Banking Financial Company – Peer to Peer Lending Platform (Reserve Bank) Directions, 2017, ¶ 4(1)(v).
5 The Directions, supra at ¶ 4(1)(vi).
6 The Directions, supra at ¶ 4(1)(iv).
7 The Directions, supra at ¶ 5(1)(i
8 Crowdfunding and Authorisation, FINANCIAL CONDUCT AUTHORITY, available at https://www.fca.org.uk/firms/authorisation/when-required/crowdfunding .
9 Regulation on "the collection of risk capital via on-line portals", CONSOB, available at http://www.consob.it/web/consob-and-its-activities/laws-and-regulations/documenti/english/laws/reg18592e_2018.htm?hkeywords=&docid=14&page=0&hits=24&nav=false .
10 Commissione Nazionale per le Società e la Borsa, also referred to as the Italian Securities and Exchange Commission, is the Securities market regulator.
11 Articles 4-7, Regulation on "the collection of risk capital via on-line portals"
12 CSF legislation, AUSTRALIAN SECURITIES AND INVESTMENTS COMMISSION, available at https://asic.gov.au/regulatory-resources/financial-services/crowd-sourced-funding/#csf-legislation .
15 SEBI Press Release No. PR No.: 137/2016, dated August 30, 2016, available at https://www.sebi.gov.in/media/press-releases/aug-2016/sebi-cautions-investors_33094.html .
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