Crowdfunding Rules in India: Legality & SEBI Guidelines

Let’s answer the most important question first, is crowdfunding legal in India? The short answer is that Equity crowdfunding is illegal while Reward-based and donor-based crowdfunding remain legal. We understand you want to know more, let us dig deeper into the what crowdfunding really is, what are the types of crowdfunding that are legal in india and what are crowdfunding rules and crowdfunding laws in India.

Coming out as a breakthrough in venture funding business, crowdfunding is taking off in India in a positive way. With the success of the first ever live crowdfunding event at Kolkata, many ventures found their much-desired funding, but what is it really?

What is crowdfunding?

Crowdfunding is new go-to strategy for budding startups. It is the practice of pooling in of resources by numerous people, thus the term ‘crowd’, to fund prospective projects. It is an alternative finance system where funds are raised through mediums like internet-mediated registries, mail-order subscriptions, benefit events, and the like.

Crowdfunding side-tracks the moneyed investors and VCs sitting in big corporate offices and instead of asking a few people for a large sum of money it asks a large number of people each for a small sum of money to finance your big dream. It is a generic appeal more homey, comfortable and interactive than convincing VCs about your dream project.

Crowdfunding is usually done via online platforms. The fundraisers set up their public campaign highlighting the main features of their proposed project and accepting donations for the same. A creative, detailed video specifying details like nature of the venture, projected funding and fundraising deadline goes a long way in scoring investors.

These funding applications can be of any nature. They can range from charitable to educational projects to personal ventures or creative ones.

You should also watch this simple video explaining the basics on crowdfunding in India.

Now that you have an idea of what crowdfunding is, let’s dig deeper.

Types of crowdfunding

Crowdfunding varies depending on the product or service you offer and your goals of growth and reimbursement. There are prmary two types of crowdfunding that are legal in India that are donation-based, debt-based and equity crowdfunding is illegal.

Donation-Based Crowdfunding

Donation-based crowdfunding is where the investors or contributors are promised no financial returns. People usually invest because they believe in the cause as these campaigns are mostly cause-based. Nevertheless, minor tokens can be offered in order to express gratitude towards the investors.

These include fundraising for disaster relief, medical bills, charities, and other non-profit ventures.

Debt-Based Crowdfunding

This method promises the contributors their money back with interest. It is also called ‘peer-to-peer (p2p)’ lending and doesn’t account for much involvement of traditional banking.

Read more about crowdfunding for debt relief india.

Along with financial returns, the investors get the satisfaction of having contributed to the success of a prospective idea which speaks to them through micro-financing. These campaigns usually include personal startup ventures.

Equity Crowdfunding

This type of funding is different from both the above-mentioned ones as the contributors become part-owners of your company. They acquire equity shares in exchange for capital receiving return on their investment as well as a share of the profits. They are also entitled to a dividend.

If the venture turns out to be successful, the share value goes up and if not, the value goes down. This type of funding is a sort of gamble which can go either way and is much more risky.

How is crowdfunding different?

Crowdfunding is different from your run-of-the-mill way of marketing your plan to banks, angel investors, or VCs.

It is much more diverse than the stereotypical way of fund-raising and hence provides you with much more opportunities in front of a larger interested party.

Source

As you may have noticed, crowdfunding has become hugely popular over the last few years, overtaking the annual funding figures of angel investors. This can be largely credited to the benefits it offers.

Here are some of the beneficial difference crowdfunding has to offer:

Wider reach – It provides you wider access to thousands of investors whom you can personally interact with instead of a few unapproachable ones. They are likely to understand your campaign better.

Presentation – It helps you look at your idea from different angles helping you understand where it needs polishing. Thus, you are able to present it in a better way to the right people.

Marketing – It is a brilliant way of marketing your business before even starting it as provides exposure to millions of users and investors. It also provides media coverage of your campaign which you can use to attract traffic to your website.

Concept validation – Presenting your concept to the masses helps you acquire validation and refine it for potential investors. You can analyze the mistakes, find out what is missing and make changes accordingly in order to put your best foot forward. If they fund you, then you know your idea holds credibility.

Freedom from banks – In the present times where it is so difficult to get funding from banks, this a profitable approach. Moreover, most banks are mostly interested in big-shot customers promising big returns and have no room for small startups.

Crowdfunding in India

Crowdfunding is nothing new to India. Since centuries we have been donating ‘chanda’ for some or the other socio-cultural cause, such as building of religious infrastructure.

The online scene is a bit of a different matter though. Crowdfunding, a concept originated in the West, much like most of other western ideas has started infiltrating the Indian masses. But, the crowdfunding scene in India is rather new with not much awareness amongst people.

A few Problems

Crowdfunding, presently in a pubescent stage, has to face a lot of problems in India. Firstly, there is no proper legal regulation setting up crowdfunding rules regarding and specifying the same.

But the lawmakers seem to have noticed the need to regulate this business model. Thus, late last year, the Securities and Exchange Board of India (SEBI) released a paper acknowledging the need for the same. It defined crowdfunding as solicitation of funds (small amount) from multiple investors through a web-based platform or social networking site for a specific project, business venture or social cause.”

Some of the other notable guidelines from SEBI’s update include:

·         Only ‘Accredited Investors may invest;

·         Qualified Institutional Buyers (“QIBs”) to hold atleast 5% of issued securities;

·         Retail Investor contribution: Minimum- INR 20,000 and maximum- INR 60,000;

·         Maximum number of retail investors- 200;

·         Only start-ups less than two years old eligible to participate;

·         Disclosure requirements such as anticipated business plan, intended usage of funds, audited financial statements, management details etc.;

·         Registered crowdfunding platform to conduct regulatory checks and basic due diligence of start-ups and investors; and Constitution of ‘screening committee’ by each platform comprising 10 persons with experience in capital markets, mentoring start-ups etc.

We say, people in India are still adjusting to a digital lifestyle where most transactions take place online. So, you can understand why they might seem skeptical about funding startup business models online.

Moreover, the industry is still unable to connect to people, though, efforts have been made in this direction.

Crowdfunding according to SEBI is the “solicitation of funds (small amount) from multiple investors through a web-based platform or social networking site for a specific project, business venture or social cause.”

Also, the crowdfunding platforms in India are still nubile and have a long way to go till they reach the status claimed by foreign crowdfunding giants like Kickstarter, Indiegogo, etc. Due to the restrictive admission policy of most of these foreign platforms, they are mostly unapproachable to budding Indian startups.

In the later part of 2016, over 20 crowdfunding platforms were deemed ‘illegal’ by SEBI. Reward-based and Donor-based platforms still operate, while equity based crowdfunding has seen a lot of scrutiny from SEBI.

Progress

The crowdfunding trend is on the rise and has already provided us with a few success stories. India witnessed its first ever live crowdfunding event in Kolkata recently. Organized by platforms like Nasscom, Catapoolt and Payumoney, it was a great success and a major step in revolutionizing the startup funding business.

Moreover, we already have a few success stories to inspire us. Startups like Spin Academy, Dabba Radio, Brahma have been able to raise substantial funding through crowdfunding platforms both Indian and foreign.

Crowdfunding is fast growing and with the right set of crowdfunding rules in place might just be the next big thing in the startup sector. It is sure to go a long way.

If you’re a budding startup thinking of treading down this path, make sure you understand the dynamics well before venturing out. Consulting your startup lawyer might be a wise thing to do for that.

You can consult startup lawyers and ask for all kinds of other legal advice, crowdfunding related and otherwise at Lawyered. Post a free question and get answers from experts.