Regulation of Crowdfunding in India: Where Are We and What The Future Holds

With the increased usage of technology and internet, many businesses have been able to tap into wider markets of consumers and vendors. Amidst the e-commerce trend, emerging start-ups have increasingly demonstrated a shift to reach out to wider options of fund-raising, leading to crowdfunding becoming a major gamechanger in several countries. Kickstarter PBC, that maintains a global crowdfunding platform focused on creativity, alone has enabled investment of approximately USD 4,862 Million in projects listed on its website[1].

The Concept of Crowdfunding

Crowdfunding means solicitation of funds from several investors to fund a project, business, or social cause. Crowdfunding is usually categorized into[2]:- (a) Donation Based Crowdfunding: The issuer seeks crowdfunding for charitable and social causes with no tangible benefit to the investors; (b) Reward Based Crowdfunding: The issuer seeks crowdfunding and the investors are offered certain tangible products or rewards (issuing pre-order discounts on products, movie tickets etc); and (c) Equity and Debt based Crowdfunding: The issuer seeks crowdfunding and the investors are issued securities (debt or equity) with promise of a financial return on the investment.

Requirement for Regulating Equity Based Crowdfunding:

Reward-based crowdfunding and donation based crowdfunding need not be specifically regulated since the provisions of Indian Contract Act, 1872, Sale of Goods Act, 1930 and Transfer of Property Act, 1882 already offer enough protection to the users of such platforms.

With regards to debt based crowdfunding, in October, 2017, the Reserve Bank of India framed the Peer to Peer Lending Platform (Reserve Bank) Directions, 2017 (“P2P Regulations”) where individual borrowers were permitted to avail loans from individual lenders through online peer to peer platforms which are registered under the said directions. The maturity of such loans cannot be more than 36 (thirty six) months and the aggregate exposure of a lender to all borrowers at any point of time, across all lending platforms is subject to a cap of Rs. 50,00,000/- (Rupees Fifty Lakh). Further, a borrower cannot avail loans more than Rs. 10,00,000/- (Rupees Ten Lakh) across all lending platforms and with respect to a single lender, such borrower cannot avail loans more than Rs. 50,000/- (Rupees Fifty Thousand) across all lending platforms.

With respect to equity based crowdfunding, in order to understand the need to regulate such funding,  it is essential to understand the reason why the Companies Act, 2013 (“ICA 2013”) has implemented private placement rules.

Under the previous Companies Act, 1956, there were no specific provisions for private placement (as corresponding to the section 42 of ICA 2013) as applicable to a private limited company. Unlisted public companies were permitted to issue and allot securities through private placement[3]. However, this process was not as stringent as under the ICA 2013.

In the case of Sahara India Real Estate Corporation Ltd. vs. Securities and Exchange Board of India[4], (“Sahara Case”) certain unlisted public companies misused the lacuna in stringent provisions of private placement and issued optionally fully convertible debentures to millions of investors under the guise of private placement. The Supreme Court in its order had held that as per the provisions of the Companies Act, 1956, any issuance to individuals beyond 50 (fifty) shall be deemed to be a public issue and the issuer companies in the instant case had violated the said provisions. Consequently, the issuer companies were ordered to refund the amounts raised by them at an interest determined by the Court.

Subsequent thereto, several stringent provisions of private placement were introduced under the ICA 2013 such as limiting the offer size to not more than 200 (two hundred) persons[5], not being able to offer or advertise to the public with regards to the securities being issued, opening a separate bank account and allotment of securities within 60 (sixty) days from the date of allotment[6].

Therefore to regulate crowdfunding, any regulatory law will have to be an exception to (a) the private placement provisions with regards to advertisement to public and offering the securities to more than 200 (two hundred) persons; and (b) the applicable provisions for listed companies, and such law should mitigate the risk of misuse of any provisions such as in the Sahara Case.

Crowdfunding in various Jurisdictions USA

The United States of America has proactively taken steps to regulate crowdfunding. The Securities Act, 1933 regulates issuance of securities by companies with the country. The Jumpstart Our Business Start-ups Act, 2012[7] amended the Securities Act, 1933 to specifically exempt certain companies issuing securities through regulated crowdfunding from filing a registration statement, prospectus and the process involved in public issue (“Regulation Crowdfunding”).

It is pertinent to note that Regulation Crowdfunding requires the crowdfunding portals to be registered with the self-regulatory authorities in United States of America. The crowdfunding portals are required to undertake investor education on risk and liquidity, take actions to reduce promoters’ fraud and undertake historical check of the issuers and their directors. The Regulation Crowdfunding also limits the maximum amount that can be raised by an issuer through crowdfunding to USD $1,000,000 (One Million US Dollars) during the preceding 12 (twelve) months.

Other Countries

In Australia, the government has recently amended the provisions of Corporations Act, 2001 to exempt issuances/acquisitions through crowdfunding from the compliances applicable to public offers[8]. In contrast, the authorities in Singapore have not provided any specific exemption for crowdfunding nor have they specifically recognised the concept of crowdfunding under the law. Companies may raise funds through crowdfunding only through small offers where the issuer can make personal offers to persons with previous connection up to a maximum limit of SGD 5 Million (Singapore Dollar Five Million) in a year or private placement where the issuer cannot issue securities to more than 50 (fifty) persons[9].

Regulation in India

The Securities Exchange Board of India (“SEBI”) in its consultation paper issued on June 17, 2014 had recognized the need to regulate equity based crowdfunding platforms (“SEBI Consultation Paper”). The SEBI Consultation Paper suggested a framework where accredited investors such as qualified institutional investors, companies with a net worth of at-least Rs. 2,00,00,000/- (Rupees Two Crore), high net-worth individuals with a net-worth of at-least Rs. 2,00,00,000/- Crores (Rupees Two Crore), retail individuals with a gross annual income of Rs. 10,00,000/- (Rupees Ten Lakh) (who will invest not more than Rs.60,000/- (Rupees Sixty Thousand) and 10% (ten percent) of their net worth in each issue).

The SEBI Consultation Paper also recognizes specific platforms that can undertake crowdfunding (including stock exchanges and technology business incubators with a minimum net worth of Rs. 10,00,00,000/- (Rupees Ten Crore) and 5 (five) years of experience).

The above framework is subject to all the applicable provisions of private placement (including the disclosures required to be made by the issuers) under ICA 2013.

Amidst the confusion as to implementation of the above framework, SEBI issued a press release[10] in 2016 to caution investors that electronic platforms facilitating fund raising on digital platforms which are not recognized or authorised under any laws and which are similar to stock exchanges are violative of ICA 2013 and Securities Contract (Regulation) Act, 1956. However, on April 03, 2018, the Ministry of Corporate Affairs clarified that post the SEBI Consultation Paper, SEBI has not formed any rules with regards to equity based crowdfunding.

Conclusion

The challenge in regulating equity based crowdfunding is to identify a balance between ease of accessing public funds and reducing the investor’s risks. Although, the SEBI Consultation Paper has tried to formulate a framework for regulating crowdfunding, there seem to be certain inadequacies in its suggestions including the following:

• The framework only applies to unlisted public companies. Due to the liberalization available to private limited companies under the ICA 2013, many start-ups, small and medium enterprises are structured as private limited companies and may not be able to tap into the crowdfunding market; and
• The framework recognizes that companies may issue securities subject to the limits prescribed by the private placement rules (i.e., maximum offerees of 200 (two hundred) persons and such offers not being a public advertisement). This may not be a viable option considering that crowdfunding will itself be open to several investors across platforms. Even if the crowdfunding platform intends to raise capital through other routes such as Alternative Investment Funds, the Securities Exchange Board of India (Alternative Investment Funds) Regulations, 2012, restricts any issuance of units through public offers.

Based on the above, it may be concluded that, any company which plans to issue securities through crowdfunding platforms needs to adhere to the private placement provisions under the ICA, 2013 thereby restricting its ability to access online markets. While there is a need to address the restrictions surrounding equity based crowdfunding, it seems that the Indian government is taking a calculative and restrictive approach to avoid mismanagement of investors’ funds. T

he views and opinions expressed in this article belong solely to the author and do not reflect the position of Tatva Legal Hyderabad.

[1] Statistics as available on date at https://www.kickstarter.com/help/stats

[2] IOSCO Staff Working Paper - Crowd-funding: An Infant Industry Growing Fast, 2014

[3] Unlisted Public Companies (Preferential Allotment) Rules, 2003

[4] (2013) 1 SCC 1

[5] Offers to qualified institutional buyers and employees under an employee stock option plan should not be considered for calculation of the 200 offerees under Section 42, Companies Act, 2013.

[6] Although this provision was not included in the Companies Act, 2013, amended vide Unlisted Public Companies (Preferential Allotment) Amendment Rules, 2011.

[7] Title III (Crowdfunding Exemption) of the Jumpstart Our Business Start-ups Act, 2012

[8] Section 6, Australian Corporations Amendment (Crowd-sourced Funding) Act 2017

[9] Section 272 A and Section 272, Singapore Securities and Futures Act, 2001 (Chapter 289)

[10] Press Release No. 137 of 2016 dated August 30, 2016