Crowdfunding – The Indian Scenario
What is Crowdfunding?
Crowdfunding is collecting small amounts of capital from a large number of individuals to finance a new business venture. It is usually done by using social media and crowdfunding websites to bring investors and entrepreneurs together, with the potential to increase entrepreneurship by expanding the pool of investors beyond the traditional circle of owners, relatives, and venture capitalists.
Purposes for which Crowdfunding is raised.
• Crowdfunding is done for business ventures specially the start-ups
• By Individuals and NGOs in cases of emergencies due to natural disasters, heavy medical expenses and personal tragedies.
• By creative persons like artists, writers, film makers and musicians for raising funds to sustain their creativity.
Types of crowdfunding
There are broadly four kinds of crowdfunding.
• Debt based fund: Debt-based fundings are normally peer-to-peer lending, the money invested is in the form of a loan and must be repaid with interest by a pre-determined due date.
• Equity based fund: In an equity-based crowdfunding, the business enterprise gives away a portion of equity for funds received. This is the only form of crowdfunding where the investor becomes a co-owner.
• Donation based fund: In a donation-based crowdfunding an individual, association or a campaign raise money for nothing in return. People who give money do it to support a cause or charity and not for anything commercial considerations.
• Rewards based: In this form of funding normally donors receive something in return for their donations, may be a complimentary book, product or service either free or at a discounted price.
Advantages of Crowdfunding
• Its ability to provide access to a larger and more diverse group of investors/donors. The huge reach of social media enables enterprises to reach out to a large number of diversified investors / donors and receive the funding they need.
• Equity-based crowdfunding is becoming very popular as it allows startup companies to raise money without spending large amount in issue-based expenses and without giving up major control to investors. Many of the countries are coming up with regulations to control of equity-based crowdfunding.
• Many crowdfunding projects are rewards based, investors may get to participate in the launch of a new product, avail services or receive a gift for their investment.
• It’s easy to invest in a crowdfunding campaign. Investors can put money through a direct online process.
• Equity crowdfunding allows investors to fund multiple campaigns, which helps them to expand their financial opportunities and diversify their portfolios.
• It helps in providing funding to new ideas. It encourages new startups in the country
• It is a boon for those poor people who can’t afford medical expenses of severe diseases like cancer and kidney transplant etc.
Disadvantages of Crowdfunding
• In some forms of the Crowdfunding, if the funding goals are not reached, money collected will be returned to the investors and the entire exercise will prove to be futile
• As a form of fund-raising Crowdfunding has the potential of damaging the reputation of a company
• Crowdfunding requires large amounts of time and effort with risk of no or little gain
• Oversaturated market
• Crowdfunding is prone to scams.
Popular Crowdfunding Websites
Crowdfunding websites are the main source of reaching to large number of diversified investors. Some of the most popular and successful websites are:
GoFundMe : GoFundMe is the largest crowdfunding platform which has raised over $15 billion through more than 100 million donors. This site is most popular for individuals seeking to raise funds for medical expense and natural disasters. 1 in 10 campaigns is fully funded on this site.
Kickstarter : Kickstarter is the most popular crowdfunding site for aspiring start-ups intending to raise capital from large number of investors. Kickstarter has successfully funded over 2,20,000 projects with more than $6.6 billion pledged across all projects. Kickstarter releases funds only after the campaign has reached its funding goal. It is the simplest site in which one sets a monetary goal and the amount of time to reach it and runs campaign’s story in hope of finding fund backers.
Indiegogo : Indiegogo originally started as a crowdfunding site exclusively for raising money for independent films but later taking up other projects also. Indiegogo is more flexible platform giving option of fixed or flexible models and allows the campaigner to receive funds on pro rata basis. Flexible model is easier and less risky for fund raisers.
LendingClub : LendingClub is a debt-based crowdfunding site which offers up to $40,000 in personal loans and up to $5,00,000 in small business financing for three to five years term. To qualify the company has to be in operation for at least a year and have an annual sales revenue of $50,000.
Ketto : Ketto founded in 2012 is the largest crowdfunding flatform with the goal of making healthcare more accessible to everyone. Medical care, Cancer treatment, Transplant, Education and Child welfare are some of the causes for which funds are raised through Ketto. Ketto has raised for over 2.8 lakh campaigns.
ImpactGuru : Crowdfunding on ImpactGuru helps fund emergency medical treatment or chosen cause. Anyone can raise funds on donation platforms – from a newborn child, senior citizens to NGOs. Fundraising via online crowdfunding platforms requires no liability to pay back the funds raised. So, all the amount generated can be used to cover the cost of emergency medical treatment.
Challenges of crowdfunding
• Crowdfunding is not an easy or free way of making money, it requires lot of effort to present a project idea that backers will perceive as a valuable. Success isn’t guaranteed, with the challenges faced with projects backed by crowdfunding backers have become shrewder.
• Crowdfunding works for all kinds of companies at all different stages, but the companies that have the most successful campaigns tend to have the largest and most engaged communities behind them.
• Finding and implementing a cost-effective marketing strategy before, during and after the campaign is very important
• Many projects with excellent ideas end up failing, whereas others with simple offerings flourish beyond all expectations. Crowdfunding projects tend to follow a viral method of growth and hence are quite unpredictable
Tips for making a successful pitch
• Good and quality product or service, trustworthy promoters, strong marketing efforts are essential for the success of a crowdfunding exercise.
• Developing and deploying an informative and exiting campaign material highlighting the product or service. With new crowdfunding campaigns launching daily, it’s important to make a campaign stand out from the others. Creating strong marketing materials and spreading the campaign is the best ways of gaining recognition.
• Equity crowdfunding requires more emphasis on educating potential investors who don’t necessarily have an investment background
• Communicate in a transparent manner with the backers throughout the process and even after the campaign ends. A successful crowdfunding campaign heavily banks on fostering relationships with backers.
India is the third-largest startup ecosystem in the world. Indian startups need a steady flow of investments and crowdfunding can play a pivotal role. While bank financing, security issues remain the most sought-after financing options, there is a broad concern about addressing the credit constraints faced by entrepreneurs. Therefore, it becomes necessary to broaden the range of financing instruments available to the ecosystem.
Globally, crowdfunding has proved to be a successful tool in pooling resources for innovative startups with a promising future. Policymakers and regulators in several countries have recognised the potential of these platforms. In India, however, the scope and prospects of crowdfunding have been underutilised. Compared to developed economies like China, the US, the UK, and Europe, India lacks adoption and utilisation of crowdfunding in terms of awareness, education, acceptance, and usage of crowdfunding.
The Indian market needs proper regulatory compliance laws and procedures for crowdfunding to reach its full potential. In India the scope and prospects of crowdfunding have been underutilised.
Unregulated and uncontrolled
• One of the things which is held against crowdfunding is that crowdfunding being unregulated and not under the regulatory control of SEBI or any other regulatory authority.
• Though target amount is raised from large number of investors / donors such offer is not complying with any guidelines like a private placement or IPO under Companies Act.
• Neither there is any requirement of the kind of information to be shared with the prospective investor nor checking the veracity of the information put out. Misinformation and dubious practices go on unchecked.
• Like stock market intermediaries, there is no requirement for the registration or licensing of crowdfunding website and their operations.
• The fund raisers are not under an obligation to share the progress of the project or any financial details with the donors
• The investors/donors do not have any remedy against the fund raiser for non-implementation of the project except civil remedy which is very long drawn
Regulatory Framework of Crowdfunding
The Securities and Exchange Board of India (SEBI) in its Consultation Paper on Crowdfunding in India has proposed for a regulatory framework which would be a governing procedure for the security based crowdfunding methods.
SEBI has attempted to ‘strike a proper balance between investor protection and the role equity markets play in supporting economic development and to avoid systemic risks being created in the economy’.
Eligible Investors : As per SEBI proposal only the ‘Accredited Investor’ can invest money in a project of crowdfunding. The qualification criteria of ‘Accredited Investor’ proposed includes
• Companies incorporated under the Companies Act with a minimum net worth of Rs 20 crore
• High Net Worth Individuals (HNIs) with a minimum net worth of Rs 2 crore and
• The Eligible Retail Investors, Indian citizens/NRIs who fulfil the prescribed criteria.
Eligible Entities: SEBI has proposed certain restrictions on the kind of companies which can raise funds through the Security based crowdfunding. These restrictions are:
• Qualified Institutional Buyers (“QIBs”) as defined in SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009 like insurance companies and banks.
• A company should not be promoted, sponsored or related to any industrial group which has a turnover of more than Rs 25 Crore.
• The company should not be listed on any exchange.
• A company should not be have been incorporated for more than four years.
• The company should not be engaged in real estate business and other activities which are not permitted under industrial policy of Government of India.
• The directors, promoters or associates of the Eligible Entity should not be suffering disqualifications, inter alia, from regulators such as SEBI and Reserve Bank of India.
Eligible Platform Offeror: SEBI has also prescribed certain specific requirements to keep a check on the integrity, experience and solvency of the owners of the crowdfunding Platform and the key members associated with it.
SEBI has proposed 3 categories
Class I entities : Stock exchanges and depositories are already under SEBI’s domain
Class II entities : Technology business incubators having a specialized domain knowledge in the field of startup mentoring and funding
Class III entities : include associations and networks of private equity or angel investors
Crowdfunding comes with many advantages compared to existing avenues available to startups and small ventures. Crowdfunding is not a public offer and does not trigger public offer related costs and compliances therein.
*The Author S. Prabhakar, is a Fellow member of the Institute of the Company Secretaries of India, Chartered Secretary from the UK, Lawyer, and Registered Insolvency Professional.
SimplyBiz Private Limited provides managed services in the field of Advisory, Transactions, Business Setup, Compliance, Accounting, and Taxation. SimplyBiz has its Head office in Hyderabad and branch offices in Bengaluru, Chennai, Mumbai, and National Capital Region.