The Securities and Exchange Board of India (Sebi) sent notices to as many as 10 crowdfunding platforms last week, asking them to clarify their business models and explain how they were not in violation of the securities law. Sebi is worried about small investors being sucked into unknown, illiquid companies, as these platforms operate in a regulatory twilight zone. Sebi’s discomfort also stems from the fact that none of these platforms meets the critical net worth criterion of Rs 100 crore required to set up securities exchanges.
Sebi’s concerns are valid, as crowdfunding platforms, which are in essence a link between investors and companies (typically start-ups), have been gaining popularity as alternative capital-raising facilitators, but they operate without any authorisation or registration. This is not the first time Sebi has raised these concerns. Two years ago, it had come out with a discussion paper proposing a framework to enable domestic start-ups and small and medium enterprises to raise capital through crowdfunding. However, the framework had to be dropped because it was considered “too restrictive”. The latest notices, thus, mark a new phase in Sebi’s two-year-long quest to evolve a regulatory framework for this method of raising funds.
Creating an online crowdfunding platform is, in itself, a business. Such a platform may generate revenue in various ways, such as by charging a fee from those who list projects or charging a commission per contribution. A crowdfunding platform could be structuring contributions received, as debt, or equity, or in complex convertible formats. But a peer-to-peer platform could also be offering illegal terms of profit, and enabling Ponzi schemes. It is also used by tech-savvy terrorist organisations such as ISIS. In that sense, Sebi is right in saying electronic platforms facilitating fundraising are neither authorised nor recognised under any law governing the securities market and such platforms, which are open to all investors registered with it, amount to a contravention of the Securities Contract Act and Companies Act.
But, it is equally true that there are valid reasons behind the rising appeal of crowdfunding. Conventional venture capitalists only fund businesses with the potential to scale and become profitable. What is more, VCs prefer entrepreneurs who check certain boxes in terms of educational backgrounds and a prior commercial track record. But crowdfunding can directly fund a non-profit project or a small business run by someone without stellar qualifications or a commercial track record. Thus, the model has an instinctive appeal. The “ticket size” (the minimum contribution) may be tiny. Moreover, not every “investment” is driven by commercial interests; somebody may just be looking to support a cause dear to his heart. Other investors could perhaps be buying the equivalent of lottery tickets — putting very small sums into new businesses and hoping to receive a large return on some of them.
There is, thus, clearly a need to understand how crowdfunding works, how much money is being raised, by whom and for what cause. But, regulation must not be heavy-handed, too restrictive or rigid. For example, a few years ago, the Income Tax Department proposed norms that effectively treated all funding received by start-ups as income liable to be taxed. Framing norms in this nascent sector will require understanding and coordination on the part of multiple authorities. Sebi cannot do it alone; the tax authorities, the Company Law Board and the Reserve Bank of India should coordinate and work out a model that allows legitimate crowdfunding to continue while reducing the room for abuse.
