The Indian Stock Markets regulator has proposed regulating the raising of funds through crowdfunding platforms in India.
Crowdfunding refers to the use of websites like Kickstarter.com by small companies and individuals to raise donations, debt or equity from a large number of users, usually in the tens of thousands or even millions.
The Securities and Exchange Board of India said it was not looking to regulate the donation-based crowdfunding model, where the person who gives his 5 or 50 rupees is not assured of any financial return.
But SEBI wants to regulate those crowdfunding activities that promise users a share of ownership in the receiving company, or annual interest or dividend payouts.
“In Donation crowdfunding and Reward crowdfunding, only donations or grants are solicited and no financial return in the form of a yield or return on investment is expected by the donor/grantor. Hence, such funding mostly falls outside the purview of Securities market regulator. (In India, payment of donations are mainly governed by the provisions of Income Tax Act). Peer-to-Peer Lending, depending upon whether pure lending or any debt securities are issued, are regulated by Banking or Securities market regulator. Crowd Sourced Equity Funding are mostly regulated by Securities market regulator,” SEBI said in a paper.
SEBI said crowdfunding was a genuine way to raise funds, especially for early stage companies. It pointed out that funding is often harder to get from banks and other traditional routes.
“As mentioned earlier, the 2008 financial crisis resulted in failure of number of Banks and, consequently, the new capital adequacy regulations for banks, such as Basel III were implemented. As a result, credit providers have become increasingly constrained in their ability to lend money to the real economy,” it noted.
“In this funding vacuum, peer-to-peer lending and other Crowdfunding Platforms are growing in popularity, as bank liquidity is reduced and new regulatory requirements make obtaining loans for small and medium enterprises and individuals difficult.
“In India, during the last few years, the IPO market has not been very active. Though, SEBI, has been at the forefront in facilitating fund raising by SMEs through measures like SME segment in Stock Exchanges, Category I- SME funds under AIF, Institutional Trading Platform, etc., still there is need to encourage innovative way of fund raising to provide an impetus to genuine SMEs/Start-ups and to explore other alternative models of fund raising with appropriate framework in consonance with retail investor protection.”
SEBI, however, noted that investors should not be allowed to be exploited by scamsters.
“Presently, the risk in financing Start-ups and SMEs is borne by the Venture Capital Funds (VCFs) and Private Equity (PE) Investors. In crowdfunding, these entities solicit investments in smaller sums from large number of investors. Hence, the risk taking by VCF/PE (informed investors) is substituted with retail investors, whose risk tolerance level may be very low. Retail investors may not be able to understand the risk in these investments and will be unable to bear the loss of investments.
“This may be more dangerous, considering the fact that investments in SMEs and Start-up may involve high risk and low liquidity and are generally treated as aggressive and long term investments. VCF/PE Investors will be able to negotiate a better pricing and some influence on management, which would be absent in the Crowdfunding Route, where smaller contributions are sought from multiple investors. Uninformed and unsophisticated investors (retail investors) may act with a ‘herd mentality’. There is no or less recourse to the investors against the issuer, in case of default or fraud
There is also the possibility of genuine websites being used by fraudsters claiming to be promoters of projects or of false websites being established, simply to defraud the investors or to entice individuals to provide credit card details etc,” it added.