Will SEBI’s new proposals throttle crowdfunding at birth in India?
By Raghav Hegde
Crowdfunding is a nascent industry in India, which yet to take off due to several reasons. Without a regulatory sanction from the government, the crowdfunding industry does not enjoy legal approval, and hence, more widespread credibility with the investors – both retail and institutional. Equally critical is that India is not a technologically advanced, entrepreneur-driven country, as a result most of the crowdfunding activity is restricted to the financing of films and cultural events. The non-existence of equity based crowdfunding in the country, as most of the crowdfunding in India is rewards based or lending based, is another important reason that crowdfunding as a platform for investment is yet to take off.
Nonetheless, a lot has changed in India over the past one month. The new BJP government has taken over at the center, with Narendra Modi as the Prime Minister. Mr. Modi is well known to be very friendly to businesses and entrepreneurs and was the Chief Minister of the state of Gujarat, which is the most entrepreneur-friendly province in the country for over twelve years previously. This is a big change from the prior administration which ruled over the country, which was distrusted by the entire business, investment and entrepreneurship community, both in India and abroad. So a lot is expected from Mr. Modi’s new government, which seems very serious on improving the investment and business climate in the country.
Many fresh ideas are already being put into action by the newly woken up Indian establishment to make this happen. Not surprisingly, the crowdfunding business in India is also being given a fresh hearing by the new government, especially because the IPO market has dried out in the country, and any alternative sources of investment in Indian businesses will be welcomed with open arms.
But the alacrity with which India’s market regulator, Security Exchange Board of India, better known as SEBI, came out with its draft proposal on crowdfunding in India surprised the investment community both in India and abroad. Indeed, this makes India the first country in Asia, other than Japan to propose a regulatory framework for the crowdfunding industry, which is fantastic as this gives the platform the legal sanction that it was desperately seeking for. However, as is usual with any new law in India, the devil is in the details. Before we pick out the flaws in SEBI’s proposals, it helps to state clearly that these are still “draft proposals” that are yet to be formulated into rules sanctioned by the Indian government. These draft proposals are open for comments and discussion till 16 July 2014, and can be challenged by the crowdfunding industry. Thus the final proposal may be something entirely different.
SEBI categorizes crowdfunding in the country as equity-based crowdfunding, debt-based crowdfunding and fund-based crowdfunding. Equity-based Crowdfunding will be restricted to accredited investors – by which SEBI refers to institutional investors or firms that have a minimum investment capital of around $4 million; high net worth or HNI investors or individual investors with a net worth of at least $350,000 and other so-called eligible retail investors or investors who have a declared annual income of at least $16,666 and have been filing income tax returns at least for the past three years. This gets even worse. The eligible retail investors need to pass an “appropriateness test” carried out by a sanctioned body, else can invest only through the advice of a qualified investment adviser or portfolio manager.
This proposal goes against the very philosophy of crowdfunding, which is that anybody can invest in businesses seeking funds through a crowdfunding platform, regardless of his or her income level. For instance, the premier crowdfunding site in the world, Kickstarter, has students and homemakers investing just a few hundred dollars in the start-up projects of their choice. Other countries have varying requirements for equity crowdfunding, with some opening the field to all – eg New Zealand, Canada and the United States – while others limit it to accredited investors – eg in the United Kingdom. These restrictions mean that in India only the “elite” would be able to invest in equity-linked crowdfunding in India, which acts as a major dampener for the crowdfunding business and may prevent it from ever taking off in the country, if made into a law.
If that was bad, one would be flabbergasted at the next proposal. Businesses seeking funds through equity-linked crowd funding can have no more than 200 investors, and have to set up a 10-man panel to vet these investors! This again defeats the whole idea behind crowdfunding, making it an entirely elite dominated business, with the average guy on the street being totally kept away from it. Thankfully, these proposals are only for equity crowdfunding. Reward based or donor based crowdfunding have no such restrictions.
In another disastrous proposal that puts severe restrictions on who can set up a crowdfunding platform, SEBI states that “equity crowdfunding platforms may only be set up by recognized stock exchanges and SEBI-registered depositories, government backed incubators and groups of at least 100 investors with a minimum experience of three years.” This means that young entrepreneurs just starting out cannot set up an equity-based crowdfunding platform – they may only be created by already existing institutions as just another of their businesses. This would be a regressive move.
World over, crowdfunding platforms are set up by highly driven young entrepreneurs without much experience or capital. Internet crowdfunding is a new way of doing business and attracting investment, requiring a plenty of entrepreneurial chutzpah, which none of the old existing institutions are known for.
While one should appreciate the fact that India’s market regulators are finally giving equity crowdfunding the legal sanction it requires to grow in the country, by imposing such debilitating restrictions on the platform, the SEBI seems bent upon killing the business even in its infancy. One hopes that the proposals by SEBI are successfully challenged and changed entirely long before they become a law and destroy equity-based crowdfunding in India, which is a terrific way for the average guy on the street to invest in young and promising but capital starved start-ups all over the world.